Dividends

[nickfrog]

Hello.

Most of my income is in dividends. However, my Ltd Company is now more profitable and I don't need the extra income nor I want to pay higher tax rate of (32.5%, in effect 42.5%).

What do I do ? Leave the extra income in the Company?

[ringram]

Salary sacrifice into SIPP the max amount = Zero tax.
Do it fast though

[nickfrog]

Cheers. Never thought of that. When you say "do it fast", are you saying it's not likely to be allowed for long ?

That won't help me as this won't be a one-off but a long term "problem".

Apparently I legally can wind down the Company after a number of years and simply pocket the accumulated surplus by just paying CGT on any amounts over my yearly CGT allowance.

Edited by nickfrog on Tuesday 18th March 10:48

[Shaoxter]

nickfrog said:

Most of my income is in dividends. However, my Ltd Company is now more profitable and I don't need the extra income nor I want to pay higher tax rate of (32.5%, in effect 42.5%).

Wrong way, when you include the tax credit it's effectively 25% not 42.5%:
100% - (100% - 32.5%)/0.9

If you don't need the extra income then you can keep the money in the company and claim entrepreneurial relief when you wind it up, works out to be effectively 10%.

You could also go down the morally dubious route of adding someone who's on a low income as a shareholder and paying them some dividends...

[nickfrog]

Shaoxter said:

Wrong way, when you include the tax credit it's effectively 25% not 42.5%:
100% - (100% - 32.5%)/0.9

Thanks for that. I am sure you're right but I don't understand how you're right. The basic dividend tax rate is 10% which in effect is "equivalent" to the 20% PAYE rate. So I thought the 32.5% would be "equivalent" to 42.5% in PAYE terms. If it's effectively 25% on the additional income past the threshold I can live with that happily, compared to 40% PAYE "equivalent".

I got this from HMRC:


I might have wrongly extrapolated though.

Shaoxter said:

If you don't need the extra income then you can keep the money in the company and claim entrepreneurial relief when you wind it up, works out to be effectively 10%.

That would be an option. Can I invest the money in the meantime in anything other than a pathetic business saving account ? I don't really understand the concept od Director Loan Account either, while we're at it

Shaoxter said:

You could also go down the morally dubious route of adding someone who's on a low income as a shareholder and paying them some dividends...

We've done that already but I wanted to simplify, and it's not too morally dubious as my wife and I are both directors and are running the business with a £7,000 salary each and up to just under the threshold for higher dividend rate each. We wouldn't involve anyone though if it's even remotely dubious.

Shaoxter, I really appreciate your input, sorry if I am a bit slow!

Edited by nickfrog on Tuesday 18th March 12:08

[Shaoxter]

nickfrog said:

Thanks for that. I am sure you're right but I don't understand how you're right. The basic dividend tax rate is 10% which in effect is "equivalent" to the 20% PAYE rate. So I thought the 32.5% would be "equivalent" to 42.5% in PAYE terms. If it's effectively 25% on the additional income past the threshold I can live with that happily, compared to 40% PAYE "equivalent".

There is a 10% tax credit on dividends so effectively the first £32k is tax free (assuming you're on minimal salary). You've been doing something very wrong if you're paying 20% on the first £32k! The whole point of paying a big dividend with small salary is because of the lower tax on dividends (and lower NI).

nickfrog said:

Can I invest the money in the meantime in anything other than a pathetic business saving account ? I don't really understand the concept od Director Loan Account either, while we're at it

You can invest in boring stuff like bonds and savings accounts and maybe shares and property but I think things get complicated if they start to make up a significant portion of your income (assuming your primary business activity is not that kind of stuff) and you might end up paying a higher rate of Corporation tax.

For stuff like property you'd really want that in your own name rather than the company's name in case the worst happens and your company goes under and you can lose the property. Whereas if it had been a personal purchase the liability stops with the company.

Every accountant I've talked to will say steer well clear of Director's Loan accounts

Edited by Shaoxter on Tuesday 18th March 13:34

[nickfrog]

Cheers. I think I am getting confused with Corporation Tax pre-dividend...which is 20% for on our (low) profits.

Then beyond that I still don't have a clue how it works I am afraid.

I will confess that my accountant has explained several times but I never understood the correlation between CT, credit, 10%, personal allowance etc...

I have no idea how much tax I will have to pay on income beyond the 32.5% threshold....sorry. I am good at making the money but not quite sharp at tax affairs and I don't like having to trust my accountant blindly...

[PurpleMoonlight]

Ignore the silly way HMRC calculate it.

If you are liable to 20% tax on a Dividend the Corporation Tax the Ltd pays covers it.

If you are liable to pay 40% tax on a Dividend then the Corporation Tax covers half of it, and then you are liable to pay the other half (this half is equivalent to 25% of the net Dividend).

Never really understood why HMRC operate the 10% tax credit, but what it does in effect is allow you slightly higher income at the 20% tax rate. £1000 gross Dividend means £800 to the shareholder and £200 to HMRC, but for personal income tax calculation purposes HMRC gross the £80 up to only £889.

Edited by PurpleMoonlight on Tuesday 18th March 17:18

[nickfrog]

PurpleMoonlight said:

If you are liable to 20% tax on a Dividend the Corporation Tax the Ltd pays covers it.

If you are liable to pay 40% tax on a Dividend then the Corporation Tax covers half of it, and then you are liable to pay the other half (this half is equivalent to 25% of the net Dividend).

I think that helps. If I ignore your last paragraph, which I omitted from the quote for simplification, am I right in saying that Dividend Tax is exactly equivalent to Income Tax, as in if I "enter" either higher income tax zone OR the higher dividend tax zone I still end up paying 40% on the income beyond the respective threshold ?

If that's the case then fair enough. Although the benefit would be that with dividend, I can defer income over threshold to a poorer year in the future ? But will not gain much interest on that money in the meantime. The other benefit being a NI saving obviously (but that applies with or without going over the threshold).

THANKS !!

[PurpleMoonlight]

Yes that's correct.

The combined tax HMRC gets is the same as if it was all PAYE (ignoring the nil rate band).

[nickfrog]

Thanks a lot !!!

[sumo69]

PurpleMoonlight said:

Yes that's correct.

The combined tax HMRC gets is the same as if it was all PAYE (ignoring the nil rate band).

How can it be when you have omitted the effect of both Employers and Employees Class 1 NIC?

Baically, if your salary is £7k (it should be higher at £7755 if your trying for a pefect solution) leaves you around £34k gross each of the basic rate band. This equates to a fraction over £30.5k of actual dividend payment that you can have tax-free. Anymore up to £100k gross each is effectively taxed at 25p in the £ received - say you have taken £40.5K dividends:

Shortcut: £10000 @ 25% = £2500

The way HMRC calculate it:

£10000/0.9 = £11,111.11 gross

At 32.5% = £3,611.11

Deduct 10% tax credit = £1,111.11

Income tax due = £2500.00

HTH?

David

[PurpleMoonlight]

To pay a net Dividend of £10,000 the Ltd will pay £2,500 in Corporation Tax. So the total tax HMRC gets is £2,500 from the Ltd and a further £2,500 from the shareholder (assuming higher rate tax), total £5,000.

If the £12,500 was passed through PAYE then the tax would be 40%, so £5,000.

HMRC gets the same either way.

No account has been taken of NIC as we are talking about tax. Dividends don't attract NIC which is why Ltd owners usually pay minimal PAYE and maximum Dividends.

[Shaoxter]

PurpleMoonlight said:

No account has been taken of NIC as we are talking about tax. Dividends don't attract NIC which is why Ltd owners usually pay minimal PAYE and maximum Dividends.

NI isn't insignificant as there's both employers and employees NI to pay which amounts to over 20%. Never thought about dividends/PAYE from HMRC's perspective before and it is interesting to note that they're the same overall but I'm not sure that's helpful for the OP.

The advice to increase the base salary past the NI threshold (£149 per week) should definitely be taken for State Pension reasons.

[Jockman]

I may be missing something here but last time I looked Dividends were not classed as EARNED income unlike salary and BIKs.

Pension contributions are based on EARNED income so in this case only £7k (plus any BIK amount) could be put (each) into pensions.

Therein lies the sting in the tail with Dividends

[PurpleMoonlight]

Jockman said:

I may be missing something here but last time I looked Dividends were not classed as EARNED income unlike salary and BIKs.

Pension contributions are based on EARNED income so in this case only £7k (plus any BIK amount) could be put (each) into pensions.

Therein lies the sting in the tail with Dividends

The OP owns his own business.

The pension contribution would be an employer one and is not linked to earned income.

[Jockman]

PurpleMoonlight said:

The OP owns his own business.

The pension contribution would be an employer one and is not linked to earned income.

I think you may have touched on this before

Can you expand a bit?? I too own my own business and ALL my pension contributions are from the Company but I always hark back to the days of running a SSAS and having to declare Salary & BIKs to justify pension contributions - the Administrator (Scottish Provident at that time) would always reject Dividends for calculating company contributions

[PurpleMoonlight]

Jockman said:

I think you may have touched on this before

Can you expand a bit?? I too own my own business and ALL my pension contributions are from the Company but I always hark back to the days of running a SSAS and having to declare Salary & BIKs to justify pension contributions - the Administrator (Scottish Provident at that time) would always reject Dividends for calculating company contributions

The employment/salary/contribution link was removed in 2006 and replaced with a maximum pension fund limit (Maximum Lifetime Allowance) and a maximum annual contribution.

The maximum annual contribution for the 2013/14 tax year is £50,000. There is the facility to carry forward any unused allowance from the previous three years.

I believe HMRC permits controlling directors complete flexibility on how to draw their 'income' from the business. So a minimum PAYE salary, maximum pension contributions, and Dividends should not be an issue.

Edited by PurpleMoonlight on Wednesday 19th March 17:06

[Shaoxter]

PurpleMoonlight said:

I believe HMRC permits controlling directors complete flexibility on how to draw their 'income' from the business. So a minimum PAYE salary, maximum pension contributions, and Dividends should not be an issue.

Well as long as you stay outside IR35....

[pacoryan]

Does your business need a premises to operate from? Fund a SIPP enough for a deposit, borrow the rest, have your company pay your pension fund rent.

The company can also hold an investment portfolio, that's no problem, as long as the company makes more from trading than investing, as was mentioned earlier. Drawback is it remains an asset of the company so in the event of an attack it could be lost. My language is intentionally dramatic having been the target of a vexatious and speculative attack that came out of the blue, having substantial assets off the balance sheet gave me options.