Becoming a director of a limited company will allow you to structure payments to yourself in a tax efficient manner. This is known as a Salary/Dividend Strategy. Most contractors will pay themselves a small salary and the lion’s share of their income via dividends. A complete limited company setup is included within each of our accounting packages.
As well as being the director, you are also an employee of your company and so if taking a salary (with a value above the threshold), you must register with HMRC for PAYE. As your own employer, you will also need to deduct income tax and Class 4 national insurance contributions from your salary and pay this as well as Class 1 employer’s contributions to HMRC.
We would generally recommend taking a salary of £11,000 a year (which is equal to the personal tax allowance for 2016/17), rather than the lower national insurance threshold, for the most tax efficient manner. Although you will incur employees NI on this salary, the company would save corporation tax.
The national minimum wage requirements do not apply to company directors and office holders e.g. company secretaries.
After your salary, business expenses, and corporation tax has been paid from the company, the remaining funds can be drawn as dividends payable to the shareholders, or retained in the company as capital and drawn at a later stage.
As of 6th April 2016, HMRC replaced the 10% dividend tax credit with a tax free dividend allowance of £5,000 per year for all taxpayers. You will need to pay tax on dividends above this allowance at the following rates:
- 7.5% for basic rate taxpayers
- 32.5% for higher rate taxpayers
- 38.1% for additional rate taxpayers
You should set a clear dividend strategy at the beginning of each tax year by deciding what you require to live comfortably, and then consider how much you are able to draw as a dividend. Qdos Accounting clients receive a monthly Business Snapshot which details your maximum available funds each month, allowing you to easily see how much you can safely draw as dividends.
Good planning will allow you to retain funds in your company, enabling you to create a rainy day fund should you ever need to rely on surplus funds within the company, plan for breaks from work, or draw funds at a favourable time, such as when your total income in the future does not reach the higher rate for that tax year.
Transfers for dividends into your personal account should always be made separately from salary payments.