By Lynne Gowers on 20th June 2014

Dividends – what are they? – Part 1

For a contractor or freelancer, operating through a limited company is widely regarded as one of the most tax efficient ways to conduct your business.

This is partly due to the fact that working in this way allows you to take your pay through a combination of salary and dividends, maximising your take home pay in the process.

Those new to contracting may be unfamiliar with the term ‘dividends’ and how taking a part of your pay in this way can allow you to  be more tax efficient.

In this four part series we will look to outline what a dividend is, who can claim it, why a contractor might do so, the dividend tax rates from 2014 to 2015 and other important topics that you may need to know with regards to this topic.

What is a dividend?

Broadly put, a dividend is a form of additional payment that a limited company director can take out of the earnings of his or her company. Specifically, a dividend is an amount of the company’s profits which is returned to the shareholders of that group. One reason why this is such a tax efficient way of taking pay is the fact that this profit is what you will receive after tax.

As a contractor or freelancer who is operating through a limited company, it is likely that you will be the director and principal shareholder of the organisation.

How can I take my pay in this way?

A common way for a contractor to receive their pay in this way it to take both a small salary and dividend profits.

By taking a portion of their pay as a small salary, a contractor will be taxed much less than if they were paid the entire sum in this way, as a salary is affected by income tax as well as employer’s and employee’s National Insurance.

Dividends, on the other hand, are not affected by National Insurance, making this method tax efficient.

Your salary and personal tax allowance

The vast majority of people who work and live in the UK are able to claim an Income Tax Personal Allowance. This is a portion of your pay that you can earn without paying income tax.

One way that you can take home the maximum amount possible with your pay is to keep the actual salary you take below  your personal tax allowance. This figure depends on your personal circumstances and can usually be found on an up-to-date payslip.

By keeping your salary below this figure, you can also take a higher percentage of pay from your dividends (the company’s profit). However, you must also ensure that the salary you pay yourself is above the NI threshold so that your contributions will still be amassed and you will be eligible for state benefits.

Things to take into account when paying yourself in this way:

– As a director, there is no minimum amount that you can receive as a salary

– HM Revenue and Customs (HMRC) must be notified in each quarter that there are no PAYE payments due from you if you are not meant to pay any

– End of year PAYE forms must still be completed

– You must register as an employer with HMRC (As a limited company director you are technically an employer).

Written by Lynne Gowers
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