Dividends can sometimes be difficult to understand. Many SME business owners worry about whether they can pay themselves a dividend, how to go about it and when will the dividend be taxed.
It’s certainly possible to get things wrong and then find that a payment you think is a dividend is treated for tax purposes as either a salary payment or a director’s loan, with unintended tax consequences.
Here are the key issues you should consider.
Check whether your company has enough profits
Your company may have enough cash to pay a dividend, but you need to confirm that it also has sufficient profits.
A dividend is a distribution to you as a shareholder of a company’s retained profits. Retained profits are the accumulated profits the company has made after all expenses and tax.
You, therefore, need to check that the company has enough retained profits to cover the dividend you intend to declare. For example, if you want to pay a dividend of £25,000, your company must have at least £25,000 of retained profits at the date you intend to pay the dividend.
You can check the level of retained profits by drawing up a set of company accounts, with a balance sheet. The retained profits are shown in the bottom half of the balance sheet, just below the share capital figure.
If dividends are declared which exceed retained profits, the dividend is unlawful. The payment will then be treated as a loan to you as a director/shareholder which may need to be repaid and could give rise to unintended tax consequences.
Do you want to pay an interim or final dividend?
Unless the company’s Articles of Association say otherwise, you can pay an interim or a final dividend. The type of situations where a dividend can’t be freely voted on are where a company has different classes of share (e.g. preference shares) which carry preferential dividend rights.
If you’re an SME business owner and the company directors are the only shareholders, it’s often easiest to do away with the formalities of a final dividend and only declare interim dividends.
Directors can declare interim dividends at any point during a company’s financial year, provided there are enough profits (see above) and certain legal processes are followed (see below).
Final dividends tend to be relevant to SME companies which have outside investors. The legal formalities are more onerous, for example a final dividend is only recommended by the directors and then an AGM is needed at which shareholders formally declare the dividend.
Let’s assume that we are dealing with an SME business/company whose directors are the only shareholders and that interims dividends are to be paid.
Board minutes and dividend vouchers
In order to declare an interim dividend, you’ll need to prepare minutes of a directors’ meeting and sign them as a director. This is the case even if you are the sole director/shareholder of the company.
You should also prepare a dividend voucher, also known as a dividend certificate.
A dividend voucher should be given to each shareholder in receipt of the dividend for tax purposes. Recipient shareholders should keep the voucher with their income tax records.
It is advisable that the dividend voucher is prepared as the same date as the board minutes.
Paying the dividend
The question ‘when is a dividend paid?’ often causes confusion. The payment date is important for both company accounts and the shareholder’s tax position.
The strict legal and tax position is that an interim dividend is treated as paid, when it has been declared and has become an ‘enforceable debt’.
If a dividend is paid by cheque or electronic payment, the dividend is paid when the cheque is handed or posted to the shareholder, or if paid electronically when the dividend is credited to the shareholder’s bank account.
But the dividend does not have to be paid in cash immediately, to be regarded as ‘paid’ for tax purposes. A declared dividend which is payable to a director/shareholder can be credited to a director’s loan account in the company’s accounts. At this point, if the director/shareholder is entitled to withdraw the dividend in cash from his/her loan account, the date the dividend is credited to the loan account is the date the dividend is treated as ‘paid’. This is the date that there is an ‘enforceable debt’ – usually the date the accounting entry is made in the company’s books.
For example, an interim dividend is declared on 1 April 2020, as evidenced by board minutes and the dividend voucher. The minutes state that the dividend is payable on 10 April 2020. It is this date that the company credits the dividend to the director’s loan account. The director then withdraws the cash from the director’s loan account on 21 April 2020.
When is the dividend regarded as paid for tax purposes and which tax year will the director/shareholder have to account for tax on the dividend?
The director was entitled to the dividend on 10 April, when it was credited to his/her loan account. The fact that he/she left it there and didn’t withdraw the cash until later is irrelevant. So the director/shareholder will have taxable dividend income in the 2020/21 tax year, despite the fact that the dividend was declared on 1 April 2020, in the 2019/20 tax year.
In the above scenario, if the company paid the dividend to the director early, say on 4 April 2020, then the payment would be treated as a loan to the director from 4 April to the 10 April.
The above example shows that it’s important to consider carefully the date the dividend is regarded as paid for tax purposes, and to have documentation to support this date. Should HMRC decide to investigate, they will expect you to provide such supporting documentation.
Tax planning opportunity
The above example also shows that that there is a tax planning opportunity. If you have some of your tax-free personal allowances or basic rate tax band left and your company has enough profits, and for whatever reason you don’t want to pay yourself the cash dividend now, you can still declare a dividend as immediately payable and book an entry in your director’s loan account. At this point, you can use your tax allowances (including the £2,000 dividend tax-free amount). In effect, you can ensure that your dividend falls into a specific tax year, fully utilising your allowances in that year, and then pay yourself the cash at a later date.
How often can I pay myself a dividend? Are there any risks of HMRC regarding regular/frequent dividend payments as disguised salary?
Strictly speaking, provided you have enough profits and prepare the relevant documentation, you can pay yourself dividends as often as you like. I advise paying yourself no more than quarterly, given the need to go through the processes noted above.
Many contactors want to pay themselves a monthly dividend. Again, that’s fine provided the correct minutes and dividend vouchers are in place.
If you follow the above approach, there is minimal risk that HMRC will seek to treat your dividends (even monthly dividends) as salary. However, I recommend that you keep salary and dividend payments completely separate from one another, so you can point to a clear audit trail if needed. Should HMRC launch an enquiry, having your affairs in order shows HMRC that everything has been done by the book and nothing has been missed or hidden.
In conclusion, you might think paying yourself a dividend from your company is easy. After all, it’s your company, so it’s your cash isn’t it? Alas not, if you want the benefits of operating through a limited company (and there are many), you have to abide by the law when it comes to taking money from what is a separate legal entity – it’s the company’s cash, not yours. Paying dividends, therefore, isn’t quite as straight-forward as it might seem. And getting it wrong can cost you.
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