A contractor’s guide to dividends

One of the advantages of working through your own limited company as opposed to as a sole trader, is the tax advantages of paying yourself with a mix of both salary and dividends.

But what are dividends, and how can IT contractors benefit from their tax efficiency? I’ll answer these questions and more, guiding you through what you need to know about dividends as a limited company director, writes Christian Hickmott, managing director of Integro Accounting.

What is a dividend, and who can receive dividends?

Once a limited company has paid all expenses and liabilities to HMRC (this includes VAT and taxes), it may have profits remaining in the business.

It’s from these remaining profits that the limited company (a Personal Services Company) can issue payments to its shareholder(s). These payments are called dividends.

How much to pay in dividends?

The amount that each shareholder can expect to receive in dividends will depend on the level of profits generated by the business; the type of shares they hold; and the number of shareholders in each share class.

As an example, if the business has two shareholders owning 50% each of ‘ordinary’ shares, each shareholder will receive 50% of each dividend.

Limited company IT contractors, BE AWARE: Ordinary shares here are referred to as being the most common type of share held, however it may be that your company has a different type of share which holds varying rights and restrictions. Check before taking action!

Why is a mix of salary and dividends beneficial?

The main benefit to paying yourself a combination of both salary and dividends is, in effect, increasing the agility of company-decision making. This brings with it the additional benefit of control over your take-home pay; and the opportunity to structure your income in a tax-efficient manner, as follows:

• Reducing corporation tax

A salary is a tax-deductible expense, and so the company’s corporation tax liability is calculated on profits after the salary is paid.

• Your state pension

When you draw a salary, it’ll help towards your state pension and benefits.

• National Insurance Contributions

You will pay these on salary received, but positively, there is no National Insurance applicable on dividends. Whereas, if you only paid yourself a salary, you’ll pay both Employer’s and Employee’s NICs.

• Personal tax liability

Depending on the amount you are paid through dividends, your personal tax liability could be less than if you were only being paid via a salary. This is due to HMRC’s set ‘tax free allowances,’ and the differences in tax rates (outlined below).

What’s the difference in the rate of tax I’ll pay between salary vs salary-dividends?

With dividends, it’s worth noting that you have an annual tax-free allowance of £1,000 (for the tax year 2023-24, which ends on April 5th 2024).

Limited company IT contractors, BE AWARE: The tax-free dividend allowance is reducing to £500 for the tax year 2024-25.

We’ll come back to this halving of the dividend allowance in the following section.

But as well as a dividend allowance, every UK taxpayer also gets an annual personal tax-free allowance. This means you pay no tax on earnings up to £12,570 a year -- and this tax-exempt sum of income doesn’t include dividends.

The current dividend and income tax thresholds (for 2023/2034) are:

• Basic rate taxpayer – dividends at 8.75% for income up to £50,270.

Remember, your income tax allowance is 20% when receiving salary up to £50,270.

• Higher rate taxpayer – dividends at 33.75% for income between £50,270 and £125,140.

Remember, your income tax allowance is 40% when receiving salary up to £125,140.

• Additional rate taxpayer – dividends at 39.35% for income over £125,140.

Remember, your income tax allowance is 45% when receiving salary over £125,140.

As these percentages, allowances, thresholds and numbers become complex by essentially interacting with each other, it’s at this stage that we recommend you consult an accountant, to ‘make sense’ of the numbers, and apply them to your circumstances.

For example, did you know the tax-free allowance in addition to the personal allowance means (as a basic rate taxpayer) you pay no tax on dividends up to £13,570 in the current tax year?

Limited company IT contractors, BE AWARE: This amount of tax-exempt dividends is reducing to £13,070 in tax year 2024-25.

Typically, business-owners will use their personal allowance on salary and then draw the balance of their income as dividends.

The Autumn Statement 2023 didn’t change the rationale behind this long-standing practice by limited company directors. Nor did it change – we’re pleased to say – the dividend and income tax thresholds. So, the above thresholds for 2023-24 are set to be in play for 2024-25 as well.

Can I defer dividend payments to a later tax year, to prevent my income being put into an additional rate tax band?

In short, yes. Your company can retain profits for later years – just because it has them, it doesn’t mean they need to be issued as dividends in the same tax year that they’ve been accumulated.

An accountant can recommend whether this would be beneficial to the company, but also to you as an individual. For example, it may be the case that receiving dividends in addition to your salary could push you into an additional rate taxpayer band, so you might consider waiting until the following tax year.

It’s for this reason that often contractors with limited companies opt to take a lower salary to account for the fact that they’ll also receive dividends.

At the other end of the spectrum, if you’re wondering how often your company can pay dividends -- well, as often as you like, subject of course to having the profit available!

Limited company IT contractors BE AWARE: With the dividend allowance reducing by a quite hefty £500, speak with your accountant to ascertain how this change will affect you, and whether the optimum time to take dividends might be before the change occurs from April 6th 2024.

We’d also recommend you explore what the appropriate salary-levels ought to be for 2024-25, to ensure you continue to operate tax-efficiently.

How do I pay dividends from my limited company?

Before paying the dividend, it needs to be declared by the company in a meeting of the directors – even if you’re the only director! So, you are advised to keep minutes of the meeting, and even agree the dividend declaration for your records.

Every dividend payment made needs a ‘dividend voucher’ issued by the company and again, kept for records.

Positively, some bookkeeping software can do this part for you -- it includes details such as the name and address of the shareholders, director’s signature, and details of the number of shares owned and dividends payable. It’s important to keep these on file, in case HMRC requests to see it.

Still got a nagging dividend question?

If you have any questions we haven’t answered on dividends for 2024-25, or you’d just like to chat through this staple, tax-efficient payment form for limited companies with a fully qualified accountant, you can reach out to us here.