Directors of small limited companies in the UK are able to minimise their tax and National Insurance liability by paying themselves a small salary (usually below the income tax threshold) and then paying themselves an occasional dividend from the company profits. Payment via a dividend is not liable to National Insurance Contributions (NICs) nor to any income tax (provided the amount is below the higher rate tax threshold) because dividends are paid out of company profits after corporation tax has been accounted for and deducted. But because corporation tax is lower than the standard rate of income tax it is possible for a director to minimise their tax and National Insurance Contributions and maximise their net income. Indeed, all shareholders in a limited company are able to use this method to maximise their net income.
A dividend payment is simply the method by which a company can distribute any profits that are available to its shareholders and, providing there actually is a profit to distribute, this can be done at any time that the director(s) choose.
Even if the dividend is for an amount that takes an individual over the higher rate tax threshold there may still be a benefit to being paid partly by dividend because the additional tax due is at a lower rate than would be due if the whole amount had been paid as a salary. Furthermore, paying a dividend does not affect the eligibility of a director to a personal tax-free allowance at the current rate.
However, it is prudent to remember that dividends should not be used for a director to take money from the company as and when they wish. You need to be sure there is actually enough profit in the company from which to pay a dividend. It is also important to recognise the difference between raising a dividend, which transfers the amount to the company’s profit & loss account and paying a dividend which is a cashflow. This can sometimes be a useful mechanism in order to time a dividend (for example around a particular tax year end) whilst waiting for clients to pay invoices that will cover part or all of the dividend payment.
If the company has sufficient Tax Advisors profit then it make sense to pay dividends on a regular basis, however, be aware that a monthly dividend for the same amount each month could be viewed by HMRC as a salary unless the nature of the business is consistent with a regular monthly income. In any case be sure to distinguish between salary and dividend payments by making separate payments (electronically or by cheque) and do not pay dividends through regular payments from the company bank account such as via direct debits. Note that reimbursement of expenses should also be paid separately from both salary and dividends.
The tax law known as Section 447 on Employment Related Securities (S447) was introduced by HMRC in 2004 to prevent companies deliberately paying their employees and directors using shares and dividends, rather than a salary, in order to avoid tax and NICs. S447 is typically applied to large corporations with complex remuneration schemes but its existence does mean that a director of a small business must be able to prove that the money going into their personal account is a genuine dividend and not a salary.