If you set up a Ltd company then the primary tax you will be liable to pay is corporation tax. This is the tax that is paid on a company's taxable profit. This is the equivalent of Income Tax that is paid by a sole trader/partnership.

The corporation tax main rate is 30% although many people reading this will never be paying at this rate.

The smaller companies' rate is 20% for companies with taxable profits between £50,000 and £300,000, and the starting rate is zero for companies with taxable profits of £10,000 or below.

However, if you pay yourself a dividend, your company's tax rate will be set at 20% for a small company and you will be denied the zero rate.

If both Cranleys Consulting Limited and Craig Properties Limited have profits of £8,000 for one year, we can see the effect of having different rates of tax payments under the different dividend options.

Effect of dividend on Corporation tax

Cranleys Consulting Limited has made no dividend payments, its profits are £8,000 and no adjustments made for tax are required. The Corporation tax due is £NIL.

Craig Properties Limited has made dividend payments, its profits are £8,000 and no adjustments made for tax are required. The Corporation tax due is £1,600.

As a result of making a dividend payment in the year, Craig Properties Limited has suffered a tax payment for Corporation tax of £1,600.

Key Tip: If your business has a profit of £50,000 or less, then allocate dividends to taxable profits in the most appropriate way so you can have a period in which you are not making dividends and so can keep the first £10,000 of profit, free of corporation tax.