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How do I pay a dividend?

Introduction

Director/shareholders of privately owned companies have long been able to reduce their tax and NIC bills by adopting a remuneration structure consisting of a low salary, topped up with dividend payments.

The attraction

A typical family company might make £50,000 a year in profits. At this level, the combined income tax and NIC bill would exceed £13,300. Running the business as a limited company would cut the tax on business profits to less than £8,500. The saving of over £4,800 could be used to enhance the living standards of the owner’s family, reduce the length of their working week, or provide funds for investment in the business.

So what has changed?

On 13 April 2013, HMRC announced that PA Holdings had abandoned its appeal in a complex tax avoidance case, involving the payment of dividends. It also announced that there was no change in policy towards OMBs and their dividend planning.

So that sounds OK but…..

They can still challenge dividends and treat them as remuneration if they are not voted properly.

The legal background

Dividends can only be voted from distributable reserves. These are measured using the accounting rules. It can be a particular problem in the first year of a business, if no accounts have been drawn up. How can you prove that profits have been earned before you have accounts?

Many of our clients employ us, or other bookkeepers, to keep them up to date. In this case, it is easy to prepare a simple, interim, statement, to show an up to date profit position. In fact, if the previous accounts show insufficient profits accumulated, it is ESSENTIAL to have management accounts drawn up, before a dividend is voted.

If the dividend is deemed illegal, the shareholders can be forced to repay it, and HMRC can treat the payment as a loan on which notional corporation tax (the S455 Liability) and income tax (on a beneficial loan) may be levied.

Interim vs final dividends

Most companies now pay interim dividends, which are proposed by the directors without reference to their shareholders. In private companies, there tend to be the same people, so it isn’t an issue, but it is not always the case. Interim dividends are taxed when they are paid. “Payment” in this case can mean being credited to the directors loan account, transferred to an account as requested by the director/shareholder or otherwise made available to spend (by paying down a personal credit card bill for example).

Final dividends can only be authorised by the shareholders in general meeting. They cannot approve more than is recommended by the directors (who have a duty to ensure that the company is managed prudently and in the interests of various stakeholders). As most private companies no longer hold AGMs, it is increasingly rare for final dividends to be voted. The main implication is that dividends are taxed on the date it is declared, unless a later date is specified on the resolution.

General practice

Most reward payments run on a monthly cycle, so you would expect dividends to reflect that. However, it is not always practical, or cost effective, for businesses to prepare the necessary financial reports, and hold a Board meeting to approve dividend payments on such a regular basis. In this case, dividends are usually paid, and later formalised after the company’s year end.

HMRC’s guidance

HMRC state (at EIM 42280) that, a payment cannot be earnings if there is an obligation to repay it. Furthermore, they state they “in the absence of specific evidence to the contrary, the amounts drawn do not actually belong to the director.” Problems can still arise where the later credit to the DLA is a mixed bag of dividend and/or salary/fees/bonus.

So what should we do?

Do check your Articles of Association to ensure interim (or any) dividends are allowable.

Do ensure that each dividend is properly supported with Board Minutes, vouchers and an appropriate resolution.

As far as possible, make sure you actually pay the dividend by bank transfer, rather than credit to the DLA, as this makes the payment date clear. If necessary, the cash can be reintroduced later.

Avoid dividend waivers, as thee are easily attacked under tax avoidance case law.

Remember, dividends can also be paid by the transfer of assets (“in specie” is the legal term), if cash is not readily available.

Conclusion

A low salary/ dividend top up reward package is still available for owner managers who are not subject to national minimum wage legislation. However, care is still needed to ensure dividends are properly paid and documented. Contact your adviser, or us, if you are unsure you comply. Don’t make yourself an easy target by getting the basics wrong.

 

Mixed partnerships – a thing of the past?

Introduction

Mixed partnerships have been a good way in which to retain the benefits of self-employed status for business owners, while reducing the tax burden on businesses. While there have been some attempts to limit the benefits (e.g. the ban on mixed partnerships getting the 100% AIA for plant and machinery investment), HMRC have been unable to upset the arrangements.

Until now…..

It was announced in the 2013 Autumn statement, and draft legislation issued shortly thereafter, to close down what HMRC describe as a structural weakness that has allowed businesses to artificially reduce their tax liabilities.

However, there are some very good reasons for having a mixed partnership. For example, retaining post-tax profits in a partnership will have incurred income tax and NIC if taken from the individual partners own profit share. This could reduce the available capital by up to 25% compared to funding it from a corporate partner’s share.

Companies can issue debentures as well, and this has not been available to individual business owners. This can help to reduce the cost of borrowing.

Risk minimisation is another good reason for having a corporate partner. For example, moving the employees into the company can help to protect the personal wealth of the business owners from spurious or even justifiable action under employment protection legislation. One of my clients is actively exploring this as we speak, following a wholly spurious claim by an ex-employee with emotional and mental health issues

What are the new rules?

HMRC now have the ability to increase the taxable profits of any partner in a partnership where:

  • There is a non-natural partner i.e. a company, and
  • The individual has the “power to enjoy” the profits allocated to the company, and
  • There is no commercial reason for the company to be allocated a share of the business profits, other than tax saving, and new source of funding for their business?
  • It is “reasonable to suppose” that the individual would have had a higher profit share if he/she had not been connected with the company.

Are there any defences?

The tests set out above are more objective than the initial proposals. However, they still represent a significant change in the way in which mixed partnerships are taxed. The conditions set out above do allow for some measure of protection, particularly for commercial arrangements. However, the profit sharing arrangements needs to be reviewed in detail, to ensure that they are commercially defensible.

HMRC have indicated that they will accept only a small mark up on cost recharges from a corporate partner, and will limit the tax impact of funding costs recharges so that the corporate partner makes only a reasonable return from its investment/ loans.

What action do we need to take now?

The new rules apply from 6 April 2014, so there should be no impact on any accounting period ending in the 2013/14 tax year. Having said that, it has always been open to HMRC to challenge any profit allocation they consider to be unjustified.

Review the profit sharing arrangements and amend any partnership agreement to make clear the commercial rationale for the profits allocated to any corporate partner.

For example, one of our clients uses his company profits to fund the family partnership start-up costs, so it is reasonable (in my opinion) to allocate losses to the funding partner, the corporate. Another client sold 50% of their partnership to their own limited company a couple of years ago. All properly declared on their personal tax returns, and not challenged by HMRC, so a 50% profit share would seem to be reasonable for the corporate.

Nevertheless, we are advising all clients of the threat, and suggesting they review their agreements and revise them to make explicit the commercialism of their own particular arrangements.

We cannot guarantee they won’t be challenged, but they’ll be better able to defend themselves if they are.

If you would like to explore your own position in more depth, please speak to your tax adviser, or contact us if you would like a second opinion.

And to answer the question….

With so many non-fiscal reasons to adopt a mixed partnership structure, the may become rarer, but I don’t think they are a thing of the past. In essence, closing down a mixed partnership, just because of the new rules, suggests to me that it existed for tax mitigation purposes only and therefore could have been attacked under any number of anti-avoidance measures.