Most business owners are aware of the benefits of paying a dividend rather than salary. With no national insurance being charged on dividends you can save around 20% (net of tax relief), based on employers NI charged at 13.8% plus employees NI charged at 12%. This is a big saving.
Another useful thing about dividends is that the tax is paid on 31st January following the year end rather than being deducted at source as it is under PAYE. There is more to this than the cash flow advantage. If you were to undertake tax planning that reduced your tax liability you would still suffer tax deducted at source under PAYE. However, you could claim to reduce your payments on account and hence not pay the tax if your income was from dividend.
New rules on dividends
The rules on dividends have however been tightened. It has always been the case that dividends must be paid out of accumulated realised profits (net of losses) from either the current year or brought forward from prior years. Now section 836 of the Companies Act requires that distributions are justified by reference to relevant accounts. Failure to comply with this renders the distribution unlawful and it must be repaid. This is the case even if there were sufficient reserves. In other words dividends cannot be paid without reference to relevant accounts.
Likewise dividends must be properly minuted and documented in the company’s records, failure to do so will allow HMRC to argue that the dividend was actually untaxed salary rather than dividend.
Also dividends cannot be back dated and must be paid as documented in the company records. Such back dating is illegal so dividends must be planned for rather than put through the accounting records as a convenient after the event tax planning.
The future for dividends
The future of dividends is not looking too good. So far there does not appear to be any specific attempt to challenge the business owner and shareholder with low salary (say £7,500), and the balance of remuneration paid as dividend in their capacity as a shareholder.
However HMRC have attacked dividends in several ways. The most aggressive are the IR35 regulations that require contractors trading through limited companies to be taxed on the earnings as salary rather than dividend. One way around this is to contract via an agency.
Also a well publicised case (Arctic Systems) in which the tax payer ultimately won, went to the House of Lords and attempted to prevent non commercial income splitting between husband and wife. As a consequence HMRC will change the law: a ministerial statement in July 2007 stated that legislation would be introduced to combat non commercial income splitting arrangements. This could be introduced as soon as 6th April 2012.
A tax tribunal case in 2009 (PA Holdings Ltd) found that a dividend could have National Insurance attached to it. The payment was found to be remuneration and not dividend as the relevant paperwork was either absent or non effective.
HMRC have also said in the not too distant past that they would like to introduce a tax charge on any dividend that effectively passes value to an employee in return for labour.
So in summary to get the real benefit out of taking payment via dividends:
- don’t back date dividends
- you must have relevant accounts on which the dividend is based
- ensure you have sufficient profits from which to pay the dividend
- ensure the dividend is properly documented in the company’s accounting records.
And finally, make the most of this highly valuable tax perk available to the self employed as it sounds like it may not be around until you reach retirement.
Andy Parker
Chartered Accountant, Birmingham