Contractors have a choice of working on either a self-employed basis or as part of a limited company. There are many reasons why a limited company might be a more attractive structure for a contractor than self-employment and you can find more information on that here.
The majority of contractors who run their business under a limited company structure set their income up to be split between salary and dividends. The advantage of doing this is that contractors are able to avoid paying higher or additional rate tax on their income. This is a really attractive proposition for the majority of contractors, but many don’t go this route because they are wary, thinking that setting up their affairs this way will be complicated.
While limited companies and dividends are more complicated in some ways than self-employment, with the right support, you shouldn’t have any difficulties with either.
On this page of our website, we provide a Contractors Guide to Tax on Dividends so that you can see for yourself that dividends are a really attractive opportunity and needn’t be complicated.
Dividends – a brief overview
Before talking about the tax on dividends, it makes sense to give a brief outline on exactly what is meant by dividends and how dividends work.
Put very simply, a dividend is a payment that is made to shareholders or owners of a limited company. The amount of dividend that a company pays is determined by the company directors is backed by sufficient capital. When deciding to make a dividend payment it is important to make sure that there are enough retained earnings to make the payment and that sufficient funds are left in the company to pay liabilities. Once the decision about dividend payment has been made, it must be noted in the minutes of the board meeting and produced and retained in the company register.
Tax on dividends
The 10% tax credit on dividends was abolished in April 2016. Now, the first £5,000 of dividends that you receive in any tax year will come to you free of tax. Over and above this amount, the tax due will depend on your total earnings. In a situation where the recipient is a basic rate taxpayer, their tax dues for any dividends over and above the £5,000 will be 7.5%, for a higher rate tax payer, 32.5% and additional rate taxpayer 38.1%.
How you pay your tax on dividends
If your dividend income is less than £5,000 there is no tax to pay. If your dividend income is between £5,000 and £10,000 you will need to ask HMRC to change your tax code so that the tax due can be taken from your salary. Alternatively, if you already complete a self-assessment tax return, you can declare the income there. If your dividend income is over £10,000 you will be required to complete a self-assessment tax return. If you have never completed a tax return before, you have until 5th October in the year after receiving your dividends to register to receive one.
If you are thinking about changing from self-employment to limited company status and would like help to better understand your income options, why not get in touch? At The Smart Contractor we have teams of experts ready and on hand to help you make the very best decisions for your unique situation.