Paying yourself from the business you own and run is more complex through a company than a partnership or sole trade. You can receive a dividend as shareholder and also a salary as director. A key attraction of forming a company is that there is less tax to pay on dividends. There are however possible drawbacks to this strategy. Here is our guide to the main factors you should consider when paying yourself from the company.
If you extract profits as dividend, and you do not have any other income you will waste your personal allowance. This is because tax credits on a dividend cannot be repaid. In this case, it is worthwhile paying a salary to cover at least some of your available personal allowance.
Even if you take most of your profits as dividend it is still advisable to draw a small salary to preserve entitlement to state pension and other benefits.
Salary increases the amount of contributions that can be paid into a personal pension, whereas dividends do not. You should consider setting a company pension scheme as an alternative then, if you wish to receive dividends and make a pension contribution.
Salaries can be allocated to directors at different rates, whereas a shareholder is entitled to a dividend at a fixed rate for each share. Non-working shareholders could receive dividends at the same rate as those who work. It is possible to solve this problem by creating different classes of share, with different dividend entitlements. HMRC may challenge this arrangement if they think it is wholly or mainly for avoiding tax.
Salaries can be paid even when the company is making a loss, whereas dividends can only be paid out of profits for the year, or any or any undistributed profits from previous years.
You will not have to operate PAYE on dividend payments, but it is essential that the correct procedure is followed.
Paying a salary, rather than a dividend reduces corporation tax, particularly for companies that do not pay tax at the small companies' rate (i.e. £300,000.)
There are different cash flow implications. Tax and national insurance is deducted from salaries on a monthly basis. Dividends must be paid within nine months of the company year end. Any extra income tax on dividends is due by the following 31 January, and payments on account may be required.
There are a number of factors that should be taken into account when deciding how to extract profits from the business, and in practice a mixture of salary and dividend is probably the most suitable course of action. Extraction of profits is a complex area of tax law.
Please call and discuss your plans with us.
