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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.

 

Can I avoid a tax investigation?

Introduction

So the return is in, and we can breathe a sigh of relief, but is it all over?

We are often being asked this question “What chance is there that I get investigated by HMRC?” The truth is that you cannot entirely eliminate the risk of getting investigated, but you can minimise it.

Some clarification

First we need to tidy up the terminology! The word “investigation” is emotive. It suggests that the person selected is guilty of some misdemeanour, or even a crime!

HMRC use various words on their website, and in their literature to describe the same thing. You might have a “check”, an “enquiry” or a “review”. All of these simply mean HMRC want to check that you are paying the correct amount of tax, and at the correct time.

Time limits

Generally, HMRC have 12 months from the date the return is filed to open an investigation into your return. The deadline can be extended if you file your return late, amend a previous return, or they can prove that you have deliberately misled them.

So I could get a random check, but how do I minimise the risk?

Submit your returns on time

Some people may be tempted to submit returns late, particularly if they have liabilities that they cannot afford to pay. It is much better to submit the return on time, and ask for time to pay. While the response can vary, you are much less likely to get a positive response if you have a history of filing later returns. This applies not only to tax returns, but VAT, PAYE and corporation tax returns as well.

Use the “white space” or attach additional documents (where possible)

Many investigations are raised simply so HMRC can understand figures that fall outside the “norm” expected. Using the white space to explain significant variations from previous years, or from industry averages, can help HMRC to accept the figures without opening an enquiry. If they still open an enquiry, it can help to minimise any penalties if you can show “that we have already told you about….”

Don’t fall out with your staff, spouse or lover!

Many investigations start with a simple tip off to HMRC, usually from someone with a grudge against the taxpayer. The people closest to you often know more than you care to think, and know “where the skeletons are”. While HMRC don’t always take up these leads, they can tip the balance. The worst case we handled was where a landlord fell out with his girlfriend who happened to be his boss’s daughter! He lost his relationship, his job and got a tax investigation all in one week!

Use a good accountant

HMRC will never admit it, but they do know which accountants are professional, and which ones are, shall we say, less than competent.  Using a reputable firm should ensure that your return is correct (assuming you’ve told the accountant everything). Even if it’s not, you may not have to pay a penalty, as using a good accountant demonstrated that you took “reasonable care” over the return, which is one of the main grounds for appealing against a penalty.

Fee protection

Most accountants also offer insurance against their fees if your return is selected for a “check”. Like most policies, they are always conditions, but generally claims are met.

Some accountant’s policies also give them access to free advice lines, so they can clear any difficult or contentious points before your return is submitted.

The policies are not expensive, and can often be part of a membership (e.g. FSB) or as part of your general business insurance.

It helps avoid that irritating position where you have to accept HMRC’s opinion, even though it’s wrong, because “it’s cheaper to pay the tax.”

In summary

You cannot eliminate the risk, but using a good accountant, and paying a small insurance premium, can put you in the best position to defend yourself.

Don’t be frightened by the prospect of an HMRC investigation, be prepared!