The Problem with Dividends
If you are UK based and trading in any of the financial markets, you have effectively three options of vehicles through which you may run your trading activities.
If you trade through a limited company (or you have one as part of your structure) and your taxable profits are less than £300,000, dividends tend to be one of the more tax-efficient routes of drawing income from your trading structure, as they do not attract National Insurance.
The rumour-mill has often brought up the threat of dividends from small owner-managed companies attracting National Insurance of some kind, but this has never materialised.
However, HM Revenue & Customs are now starting to crack down on the voting of dividends as they recognise the ways in which dividends can (and have been) used for tax planning.
In the last few years, since the abolition of the payment of Advance Corporation Tax on dividends in 1999, it has become increasingly easy to plan dividends in the most tax efficient way according to the recipient’s tax affairs. However, following the introduction of new International Accounting Standards, HMRC have begun to attack the tax treatment and it is now highly recommended that there are several steps undertaken each time a dividend is drawn from the company.
These steps are as follows:
- A review of the profits for the limited company to date (including those not distributed in previous years) should be undertaken to ensure that there are sufficient distributable profits in the business after accounting for all liabilities, including the accruing current year’s Corporation Tax, and any dividends previously taken.
- A note of a meeting of the directors should be drafted, signed and dated confirming that the management accounts have been reviewed and that the director(s) resolved to vote a dividend of £x. This is required as it is the directors' responsibility to ensure that there are sufficient distributable profits.
- On the date of the payment of the dividend, a dividend voucher should be drawn up signed and dated in a form which is acceptable to HM Revenue & Customs as this will form the evidence that the shareholder requires for their own tax affairs.
- Should the director have withdrawn monies ad hoc from the business such as for personal bills or cash, it is recommended that this loan should be physically repaid as soon as possible from the dividend received.
There are several sources of risk surrounding the planning and payment of dividends which need to be considered.
- Any payments made on behalf of director-shareholders by the limited company such as phone bills, or simply the withdrawal of cash by the directors may not be treated as part of a dividend payment (even if that is the intention). They could instead be treated by HMRC as a loan to the director which could have adverse tax consequences as covered later in this article (unless treated as a repayment of an already existing loan to the business).
- Any dividends drawn in excess of the available distributable profits of the business are technically repayable by the shareholders. These are known as 'ultra-vires' dividends, and will also cause the same adverse tax consequences as an outstanding director's loan.
- Should the meeting notes and dividend voucher not be drawn up, it is possible that HMRC will not recognise the payments as dividend payments, instead treating them as drawings by directors against a loan account resulting in the same adverse tax consequences.
- If payments are not treated as dividends in one tax year, it would be possible to incur additional higher rate income tax if "double" dividends are voted in the following year to catch-up.
- If payments are not treated as dividends in a tax year, actual income figures for the individual(s) in question will be depressed which could cause problems for the raising of any personal finance (such as mortgages)
Loans to Directors/Shareholders
Officially known as "Loans to Participators", HMRC have long been targeting companies that have provided a loan to a director in two ways:
- Firstly, a loan to a 'participator' exceeding £5,000 at any point in the accounting year will attract a benefit in kind charge equivalent to the amount that would have been paid had the loan been provided at a commercial rate of interest. This charge is taxable at the individual's prevailing rate of income tax and a Class 1A National Insurance charge of 12.8% is payable by the company. If interest has been paid at a commercial rate on the loan, then no benefit in kind is payable.
- Secondly, should the loan be still outstanding nine months after the end of the accounting year, a temporary tax charge (known as a s419 charge) is levied on the company at the rate of 25% of the outstanding loan at that point. This tax is refundable to the company in the year after the repayment of the loan.
Successful Tax Planning with Dividends
Having read this far, you may now be thinking that drawing dividends is fraught with problems!! However, successful planning for dividends is still very possible and relatively easy provided that the planning is completed upfront, and the paperwork is completed correctly.
For many limited companies, dividends are drawn as a regular monthly/quarterly payment and thus the paperwork could be seen as a regular but necessary evil.
However, if you wish to take varying or additional amounts during the year and/or where the level of distributable profits is uncertain, further planning should be undertaken earlier rather than later.
Where regular dividends are taken, and the level of distributable profits are not in question, A4G can provide you with the necessary blank forms for you to fill in and complete as necessary free of charge.
If you would rather A4G complete the paperwork on your behalf, then we would be happy to complete this on your behalf at least 4 days prior to each payment. This would incur an additional charge of £35 plus VAT per shareholder per payment. This may also be completed at a discount at the start of the financial year if regular dividends will be taken, and will in effect replace a large element of any tax planning previously undertaken later in the year.
If you are uncertain of the level of distributable profits, and require a review of your current profit levels, then please call your Principal Adviser or contact us to discuss your requirements and quote for this work on an ad-hoc basis.
Of course, dividends are not the only form of tax planning, and if you are regularly drawing more than around £50,000 from your limited company, or your profits exceed £300,000 you may wish to consider changing your business structure to a hybrid Limited Liability Partnership structure which could offer greater flexibility together with the possibility of excellent personal tax savings. Please ask your Principal Adviser for details or contact us if you would like to discuss your options further.
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