It’s important to have a tax-efficient strategy when it comes to taking profits for family and personal companies, as this will make it possible to take a salary and additional funds that are required beyond the company as dividends. So, taking a salary is not governed by restrictions, but if the company is not making any money and posts a loss then this cannot be said about dividends.
The Importance of Retained Profits
Only where there is retained profits can dividends be paid. However, should a company record a loss for a certain year, this doesn’t necessarily stand for the payment of a dividend, providing the company did have retained profits at the beginning of the year and that the loss has not completely removed the profits.
An example of this is Sally, who owns a personal company 1 Ltd. Every year, she prepares accounts to 31 July. On the 1st August, she has £25,000 in retained profits. However, she expects to make a loss this year of £5,000. Therefore, she will be left with retained profits of £20,000 after taking the predicted loss into consideration.
Should funds be required outside of the company yet any future profitability is unknown, it could be worth obtaining dividends while there are retained profits ready to access.
Using the example above, if we assume that Sally has cash available, she might choose to use all of the retained profits as a dividend while possible. This will ensure that she can explore the tax benefits of dividends. Should she make any additional losses, all remaining profits will be eliminated and this means that it won’t be possible to take a dividend.
There will be no tax applicable to the dividend where it is protected by the dividend allowance which is set at £2,000 as well as any personal allowance that has been unused. After this, there will be a tax rate of 7.5% applicable to dividends that fall within the basic rate band. If they fall within the higher rate band then a rate of 32.5% will be applicable while this increases to 38.1% for the additional rate band. However, National Insurance is not applicable on dividends. Along with this, it makes sense to have management accounts ready that indicate that the company did have retained profits at the time the dividend was paid, just in case HMRC challenges the situation.
No Retained Profits
If there are no retained profits then you won’t be able to pay a dividend. If payment is made as a dividend then it will be illegal and HMRC might challenge it. This could lead to it being changed to a salary or bonus payment and with this comes tax.
Despite this, if the company is making a loss and money is needed to cover personal liabilities, it’s possible to take advantage of a higher salary or bonus even if this adds to the total loss. This bonus payment or salary, as well as any employer’s National Insurance associated with it, will be deducted when calculating the taxable loss and this could be used to create a repayment of corporation tax.