Salary and Dividend Strategy 2014/15

As a director and shareholder of your own company you can decide how much salary to pay yourself each month in order to use your tax-free personal allowance in the most tax efficient way. Any further funds you need can be extracted as a dividend if the company is making a profit.

If you are a director of your company and you don't have a contract that sets out terms of employment with the company, you don't have to pay yourself the national minimum wage. So how much should you pay yourself?

For 2014/15 if you were born after 5 April 1948 you have a tax free personal allowance of £833 per month (£10,000 per year). You could take a salary at that level and pay no income tax, assuming you have no other taxable benefits from the company such as a car.

However, you will pay national insurance (NICs) on that salary as the NICs threshold is only £663 per month. From a gross salary of £833 the company must deduct NI of £20.40 and set-aside employer's NI of £23.46 on top. The company will have an employment allowance of £2,000 for the year to set against its employer's NI due on all its employees, so it won't have to pay over employer's NI until that £2000 is used up.

If you take a salary of just above the NI lower earnings threshold of £481 per month, you will get an NI credit towards your state pension, but you don't pay any tax or NI. However, at that annual salary level (£5,772) you will be "wasting" £4,228 of your tax free personal allowance, unless you have other income to cover it.

Talk to us about the best salary level for you, which takes into account all your other sources of income.

Overdrawn Dividends

Under company law shareholders must not withdraw more dividends than the company has retained profits. So what happens if you find yourself in a position where you have done just that?

The overdrawn amount will be reclassified as a loan within the company accounts and where the loan is to a director, employee or related party the following rules apply:

• If the loan is more than £5,000 then there will be a benefit in kind (BIK) charge within the income tax return every year until the loan is fully repaid
• If there is a BIK then the company will suffer a Class 1A NIC charge every year until the loan is fully repaid
• If the loan has not been repaid to the company at the point that the company is due to make its corporation tax payment (i.e. 9 months and 1 day after the company year end) then it must pay a penalty tax charge in addition to its corporation tax.

The penalty tax is 25% of the outstanding loan amount. Whilst the penalty tax will be repaid to the company once the loan is repaid, beware; there are specific rules regarding when the repayment may be claimed and it will take time to recover the monies from HMRC which can have a serious effect on the company’s cashflow.

How can you ensure you do not end up in this situation? Well the obvious answer is not to withdraw more dividends than are available. To do that you need to ensure that the company’s records are updated regularly throughout the year so that you can keep track of your profit and the estimated corporation tax that will become due.

Defacto recommend records are updated a minimum of once per month.

If you think you may have overdrawn dividends or if you need assistance with record keeping and tracking company profits throughout the year, please contact us.