Payment of dividends to working shareholders

[RichardW]

I am the MD and 80% shareholder of a limited company. I have two employees who each own 10% of the company. The employees have been paid a salary in tax year 2004/5 to date of £14k. If I stop their salary for the reaminder of the tax year and pay them by means of a dividend of say, £5k each, what are the tax implications?

[Lambs]

VERY simply, you would avoid employer's NIC, and they would receive more net income, as dividends would not be subject to (further) income tax, or to employee's national insurance, assuming that they have no other income which would put them into higher rates. Note, however, that dividends are not an allowable expense in the books of the company.

However, tax-savings aside, there are some practical problems to consider:

You are all shareholders: if you pay them a dividend, then you must pay yourself a corresponding amount - £40k here - unless you start waiving entitlements. You must also have sufficient distributable reserves, (broadly, profits retained in the company), to support such a dividend - the pre-waiver amount of £50k.

If they have contracts of employment, (and the courts will normally infer one, at least), then they can sue for their salary, regardless of dividends, unless some formal agreement is drawn up: note that dividends are a return on their investment as shareholders, and nothing to do with any work they do as employees.

Of course your co-shareholders may be family or friends, but then you have to be careful about the "Settlement anti-avoidance provisions," which the Revenue are currently using to beat husband-and-wife limited companies over the head, or trying to at least.

I suggest you speak to your (an) accountant/tax adviser, so as to make sure that this general advice is tailored more specifically to your particular circumstances. I should think that the potential savings are well worth the initial outlay, provided you "tick all the boxes."

[Lambs]

Sorry, should also have added that now dividends can also carry an effective additional Corporation tax charge, where your profits are below the £50k per annum mark. However, taking everything in the round, it's still likely to be beneficial from a tax perspective, even if the new rules for "Non-Corporate Distributions" do bite.