Is your dividend legal?
Being professional Chartered Accountants means that we keep our clients within both company and tax law; we ensure our clients strictly adhere to the rules on dividends, so they needn’t fear scrutiny by the Revenue.
Another reason for clients dealing with dividends correctly is it also helps them to know their numbers; it is so important for business owners to understand what is happening with their business finances and therefore take what cash the business can afford that is legally available to them. Guidance from the ICAEW can be found here.
Many small companies have a structure where the business owner, in his capacity as a director, has a small salary to cover the tax free personal allowance, and which falls within the National Insurance band where contributions are made by HMRC but not the employee (director). The balance of the income taken, typically monthly, is by a distribution of the profit to the owner, in his capacity as shareholder, called a dividend; herein lies the source of a potential problem. The basic Tax Minimisation Strategy to take advantage of this split for 2013/14 is for an annual salary of £7,695 and dividends of up to £30,380, keeping below the 40% threshold. The dividend amount is such that gross income is £41,450 (£7,695 +£33,755) which is the maximum before the 40% tax rate.
With the recent budget announcement targeting tax avoidance surrounding loans to participators, it is even more important to understand your limited company numbers and apply the process correctly.
The first step in deciding if a dividend can be paid is to calculate the amount of profits after the provision for corporation tax. It is only after this figure is available that the company can have a board meeting to agree any dividend and this can be distributed according to the share holding. Without either of these two steps having been taken, a dividend has not been voted at all.
The business should be in a position to report its profits on a monthly basis and vote the correct distribution to its shareholders. We would recommend you regularly use bookkeeping software, such as Sage, to keep track of your business finances, and we have successfully helped many businesses to understand the process of keeping records to legally vote dividends.
Should the business owner get the numbers or process wrong or simply ignore them, the company either might have insufficient profits to legally declare a dividend or will not have actually declared a dividend at all. Unfortunately, and depending upon the circumstances, the effect of this will mean that:
- either the amount paid is treated as salary on which both PAYE and National Insurance should have been applied, creating penalties and additional tax payable, or
- the illegal or non-declared dividend is repayable, normally creating a loan to the Director that is potentially taxable on the company under s455 of the Corporation Taxes Act 2010 (loan to participators legislation). It is how and when this loan is treated as being repaid that is the subject of the recent announcement, published in detail in the Finance Bill 2013 on 28 March 2013).
The corporation tax charge under s455 is 25% of the balance of the loan at the company’s year end, and is repaid only nine months after the end of the year in which repayment occurs, effectively causing a cash flow problem for the business. The new legislation could make this an even bigger problem.
The loan also attracts an interest charge currently of 4% payable by the director on the outstanding loan during the year, and is reportable on the annual P11D as a benefit in kind, bringing more administration to the business and a higher tax charge for the director and/or the company.
The 25% corporation tax charge can be avoided by the loan being repaid within 9 months. Companies have sometimes tried to do this subject to the common practice known as “bed & breakfasting” whereby the outstanding loan to the participator (director) is repaid and then in the next few days is paid back, therefore having technically complied with the legislation. Slip-ups can occur in this process and extreme care needs to be taken to ensure that non-payment of tax is not classified as illegal evasion.
The “bed & breakfasting” has now been addressed by the legislation laid out in the Finance Bill 2013 and from 20 March 2013, any repayment of at least £5,000 that is paid out again within 30 days will not be treated as repaying the loan and the 25% charge will stand. In addition to this, any outstanding amount of at least £15,000 that is repaid with an intention to redraw an amount and again create a loan to the participator will still result in the 25% charge.
It is without doubt that owner/directors of many small limited companies find that the tax saving after additional compliance fees is not enough to justify either the cost of employing a book-keeper and they find it difficult to cope with the additional administration that is a feature of operating a business within a limited company structure. Changing the business structure from limited company to sole trade or partnership may be the right decision.
If the company has been set up mainly for tax planning, regularly has an overdrawn directors loan account, and compliance with such complex legal requirements is a challenge, we would recommend that the owner/directors should seriously consider taking advantage of the new provisions (from 1 April 2013) giving a time-limited relief for disincorporation. The business owner then operating a sole trade or partnership is of course still under a legal obligation to keep accurate records but the additional legal requirements of operating a company will not apply.
For advice on any points above, please just firstname.lastname@example.org