Dividends are a useful part of a profit extraction strategy.

A dividend is a payment made by a company to its shareholders, usually as a distribution of profits, in order to provide a return on the investment that the shareholder has made.

A dividend is allocated as a fixed amount per class of share, so shareholders receive a dividend in proportion to their shareholding. The payment is usually cash, but may be paid in shares or other assets, known as a dividend in specie.

Under the current taxation system for dividends, a dividend is deemed to have had basic rate tax paid on it – the dividend tax credit. Unless you are a higher rate taxpayer there will be no further tax when the dividend is paid.

A dividend can also be used to provide an alternative compensation package for shareholders who are employees, as the fact that there are no National Insurance Contributions (NICs) on dividends can save tax for both the company and the shareholder. However, as this is a distribution of profit there is no tax deduction for the payment of dividends as there is for wages and salaries, however the combined rates of dividend income tax and corporation tax is currently equal to the rates of income tax on salaries.

The government has announced that this system of tax will change from April 2016. Under the new system there will no longer be a tax credit system. Each taxpayer will receive a £5,000 dividend tax-free allowance, after which dividends will be taxed at a rate 7.5% higher than the current effective rates of tax.

This change will largely remove the tax advantage of paying dividends due to there being no NICs on them, however the other benefits of trading through a limited company will still remain (limited liability, spreading profits over spouse/family tax allowances etc.).

If you would like to discuss dividends and profit extraction, please email customerservice@taxinnovations.com or call us on 01962 856 990.

For an initial consultation please call us on 01962 856 990 or visit our contact page.