Dear Contractor Doctor,
I am a contractor. I trade via my own limited company and pay myself via a combination of salary and dividends.
If I pay myself (as a director and shareholder) a regular dividend from my limited company, when is the tax on that dividend payable to HMRC?
Contractor Doctor explains how dividend work:
“Dividends tend to be taxed in the tax year in which which they are paid and are generally requested by HMRC via payments on account at two intervals throughout the year,” explains James Abbott, founder and head of tax at contractor accountant Abbott Moore.
“This may seem fairly obvious, and generally the taxation of dividend payments is very straightforward. However, things can become a bit more complicated for the contractor should they decide not to pay the dividend from their company to themselves personally on the day that it is declared.”
Contractors who don’t pay attention to the timing of their dividends can also find themselves paying more tax unnecessarily, so it always pays to keep a close eye on your distributions and the tax bands you have available throughout the year.
When are dividend taxes payable?
The question of when dividend tax is payable to HMRC is simple. Abbott notes that contractors are expected to make tax payments to HMRC twice throughout the year. Initially by the 31 January self-assessment tax return deadline, and then by 31 July, which is the date by which payments on account are due.
The amount of tax a dividend incurs is dependent on the tax year within which it is either paid or recorded. For example, if a contractor takes a straightforward dividend whereby the money is immediately taken out of the company account on 4 April 2017, it falls within the 2016/17 tax year and so will incur the relevant tax rates.
However, if a contractor decides to declare a dividend but opts not to take the money out immediately, the tax paid on the dividend would be dependent on when the dividend is logged in the company records.
“So, if a contractor declares a dividend for their company today, but doesn’t enter it into the company records until next week, it would be classed as a dividend next week.”
Why do I need to keep records of dividends?
According to Abbott, this places a lot of emphasis on bookkeeping for limited company contractors, who can encounter problems if they aren’t thorough enough when recording dividends.
“It’s important to keep a proper set of records. But to be honest, most smaller businesses don’t. In which case, you would need to think about alternatives. If you use bookkeeping software, you simply log the dividend in the records and therefore the dividend hits your tax return at that particular point. If you don’t have a full set of books, we tend to suggest that you raise a board minute to acknowledge the payment.”
He adds: “If the money’s paid out of the bank account it’s straightforward. If it isn’t paid out immediately, it depends on when it’s put through the company’s books, and therefore the date on which you record the transaction becomes really important.
“Make sure you have the paperwork to support your claim as to when a dividend has been paid. It’s vital to raise dividend vouchers to act as evidence to back up claims as to when dividends have been paid, as HMRC does request them.”
How can I benefit from timing dividend payments?
“Company owners are in a really good position when it comes to withdrawing dividends because they can time when the money is transferred from their company into their account,” notes Abbott. “Occasionally, this can be beneficial from a tax point of view.”
Abbott uses the relatively simple example of a contractor who is approaching the end of the tax year. They would normally pay themselves a dividend at this point but their dividend income for the tax year is hovering just below the threshold for higher rate tax.
Rather than taking a dividend prior to the end of the tax year and incurring dividend tax at a rate of 32.5%, the contractor can opt to delay their dividend payment until 6 April onwards. By this point they will have a fresh basic rate tax band to use up, on top of their personal allowance and Dividend Allowance.
Alternatively, if you are approaching the end of the tax year and have some of your basic rate band left to use up, you may wish to withdraw a dividend that takes you up to just below the limit.
Monitor your dividends and timing
Abbott concludes: “So, by putting some thought into the timing of dividends, contractors can consider what puts them in the best position from a tax perspective.”
If you’re a limited company contractor paying yourself via dividends, be sure to monitor your company profit and your tax position throughout the year to avoid inflated dividend tax payments.