As a director of a UK limited company, it is essential to follow the correct process when declaring dividends. Many directors mistakenly withdraw money from their company before formally declaring a dividend, which can lead to cash flow issues and potential tax penalties. This article outlines the proper steps to ensure compliance and avoid costly mistakes.
For expert guidance on dividend declarations and tax implications, don’t hesitate to get in touch. At Lava Sky Accounting, we’re here to help you stay compliant and keep your business financially secure.
What is a Dividend?
A dividend is a distribution of a company’s profits to its shareholders. Unlike salaries, dividends can only be paid if the company has sufficient retained profits after all expenses and liabilities have been accounted for. If dividends are taken without available profits, they may be classified as illegal or treated as a director’s loan, potentially attracting tax charges.
Steps to Properly Declare a Dividend
1. Ensure Sufficient Profits
Before declaring a dividend, review the company’s financial statements to confirm that there are enough retained profits available. A company cannot pay dividends out of expected future profits; only realised and available reserves count.
2. Hold a Board Meeting
Even if you are the sole director, you must formally approve the dividend at a board meeting. The decision should be recorded in meeting minutes, detailing the amount and date of the dividend declaration.
3. Prepare a Dividend Voucher
For each dividend payment, a dividend voucher must be issued to the shareholders. This document should include:
The company’s name
The shareholder’s name
The date of payment
The dividend amount
The signature of an authorised director
4. Pay the Dividend Correctly
Dividends can be paid directly to the shareholder, or credited to a director’s loan account if the shareholder is also a director. Ensure that payments are made in accordance with the company’s financial health to avoid cash flow problems.
Tax Considerations for Dividends
Dividends are subject to dividend tax rather than PAYE or National Insurance contributions, making them a tax-efficient way to withdraw profits. However, shareholders must report dividend income on their self-assessment tax return.The dividend allowance is the amount an individual can earn tax free each year. This is currently set by HMRC at £500.
So, you only pay tax on dividend income above this allowance. In addition, you do not pay income that falls within your personal allowance (£12,570) if this hasn’t already been used from other income.How much tax you pay depends on if your personal allowance has already be utilised and any other income you may have recieved. All these elements are taken into account to determine your dividend tax band. The current dividend tax rates (as of 2024) are:
Basic rate: 8.75% (for income between the personal allowance of £12,570 and £50,270)
Higher rate: 33.75% (for income between £50,271 and £125,140)
Additional rate: 39.35% (for income over £125,140)
Dividends paid incorrectly may be reclassified by HMRC as salary or a director’s loan, attracting income tax and National Insurance liabilities.
Common Dividends Mistakes and How to Avoid Them
Taking Money Before Declaring a Dividend
Directors sometimes withdraw funds assuming they will later declare a dividend to cover it. This approach can lead to complications if the company lacks sufficient profits at the end of the year.
Failing to Document the Dividend Properly
Always prepare board meeting minutes and issue dividend vouchers. This documentation serves as proof that the dividend was correctly declared.
Confusing Dividends with Salary or Loans
Unlike salaries, dividends do not attract National Insurance but must still be properly accounted for. If a director withdraws money without a formal dividend declaration, it may be treated as a director’s loan, which could result in tax charges if not repaid within nine months of the year-end.
Conclusion and Best Practices for Declaring Dividends
To ensure dividends are declared correctly and tax-efficiently:
Always check available profits before declaring a dividend.
Document the decision through board meeting minutes and dividend vouchers.
Pay dividends from company profits, not anticipated earnings.
Keep proper records to avoid HMRC scrutiny.
By following these steps, UK limited company directors can avoid cash flow issues, stay compliant with tax regulations, and maintain a financially healthy business.
If you need further information or professional advice on dividend declarations and tax implications, feel free to get in touch. At Lava Sky Accounting we are happy to help ensure your business remains compliant and financially sound.