Where there are several shareholders, profits can be extracted tax-free by paying dividends to each up to the basic rate limit. Where shareholders have other income, the best result is obtained if the gross dividend is equal to the unused portion of their basic rate band.
However, unlike salary there is no flexibility to choose how much to pay each shareholder as dividends must be paid in relation to shareholdings. However, this restriction can be overcome by having different classes of shares for each shareholder so the dividend paid to each shareholder can be tailored each year.
Example:
DEF Ltd is a family company. Nick and his wife Rachel are shareholders and directors. Nick holds 100 A shares and Rachel holds 100 B shares.
In 2013/14 Nick has other income of £10,000 and Rachel has no other income. The personal allowance is £9,440.
Paying Nick gross dividends of £31,450 will take his income up to the basic rate limit of £41,450 for 2013/14. This is a net dividend of £28,305 or £283.05 per share.
As Rachel has no other income, she can receive gross dividends of £41,450 before paying any additional tax. This is equivalent to net dividends of £37,305 or £373.05 per share.
By declaring an A class dividend of £283.05 per share (net) and a B class dividend of £373.05 per share (net) the dividends can be tailored to utilise the remaining basic rate band and personal allowances of both Nick and Rachel.
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