The dividend dilemma

So your company has started to make a bit of money and you’re wondering whether it’s more tax efficient to let the profits mount up or take them from the business in the form of a dividend.

Firstly, if you don’t need to take the money out of the business for any reason then it’s probably best to let it accumulate in your account. I’ll explain why a little later.

If however, you’re a small business owner who has perhaps only being paying yourself the bare minimum until your business became more profitable then then that’s a whole different scenario.

Nothing’s ever certain

One thing to remember when deciding whether to pay yourself dividends are that rules and legislation can change. Therefore, working out the tax efficiency of whether to draw company profits or let them accumulate means that it must be assumed that current rules will apply well into the future.

To draw or not to draw

So, currently the most tax-efficient ways to take profit from your business are:

  1. draw a dividend
  2. accumulate the profit until the business is sold or wound up

If you’re that small business owner I was talking about earlier, then for now you’ll be most interested in option one. However, if you fall into the second category you’ll be interested in weighing up the tax efficiency of both options.

How much tax will I pay on 2014/15 dividends?

Income tax rates range from zero to 30.55% of the dividend amount you receive. So how do we work it out? Firstly, we need to increase the dividend by 1/9th e.g. for a dividend of £2,700 the taxable amount is £3,000. The next step is to add the taxable amount to your other income. The table below shows you what your tax rate is if your total income for 2014/15 falls into one of the following brackets:

Total   incomeTax   rate
<£419650%
£41965 – £150,00025%
>£150,00030.55%

How much tax will I pay on accumulated profit?

If on the other hand you decide to accumulate your profit until such times as you sell or wind up your company then the rate of tax you’ll pay is just 10% capital gains tax (CGT), known as entrepreneurs’ relief rate.

A no-brainer?

If you were to draw your entire profits as a dividend (or an efficient combination of salary and dividends) you would pay income tax of between zero and 30.55%. If however, you accumulated all profits you would pay only 10% when you sold or wound up your company.

Therefore, the sensible approach is a simple one (in theory). Draw dividends up to the limit at which no income tax is payable (at the current time £41,965), then accumulate all other profits until the company is sold or wound up.

Two other approaches to think about:

  1. If your other income is uncertain i.e. everything but the dividend part, don’t draw dividends until March. Then near the end of the tax year (March) estimate your income and draw dividends that keep you within the nil rate tax band.
  2. Or draw dividends through the year and at the end of the tax year (March) if you think your income is above the nil rate tax band (£41,965 for 2014/15) you can pay a pension contribution to raise the limit at which income tax starts to be payable on dividends.

To discuss this post contact Stephen Usher on 0141 418 6550 or stephen.usher@keypp.co.uk.

– See more at: http://www.keypp.co.uk/dividend-dilemma/#sthash.qBpj12Ag.dpuf

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