Dividends; the distribution of accumulated profit to a company’s shareholders
The extraction of company profits through dividends, rather than say increased salary or bonus payments seems simple enough, however, there are considerations which if ignored could leave your company, or indeed you personally as a shareholder, with an unexpected tax liability and possible fines.
Legal or Illegal?
Directors do not need to wait until the companies year end to declare a dividend; however, they do need to check that there is enough profit in the company to cover any dividend. Simply having enough cash in the bank to pay the dividend is not sufficient.
If a director declares a dividend that is greater than the accumulated distributable income, this payment is deemed illegal and can result in increased tax liabilities, fines and possibly court action. HMRC have an obligation to pursue offenders, often through the courts, in order to redeem monies owed and potentially strike off those responsible.
Is your accountant providing you with the correct advice with regards to your dividend payments?
Class & Waivers
Selective dividends allow a company to allocate distributable income to a subset of its total shareholder population. If a company has different classes of share, it is able to distribute profit in a manor agreeable to that subset. This can be useful if one subset has additional income and wishes to receive a lower dividend than a different subset who may not have additional income and therefore are happy to receive higher dividends.
Dividend waivers operate in a similar fashion whereby a shareholder can reject a dividend, while all other shareholders in that class take the payment.
Both of these structures require the correct administration in order for them to comply with the relevant legislation; however, once in place, these can be powerful tax-planning tools.
10% Tax Credit
Dividends are paid with a 10% Tax Credit, in practical terms that means for every £900 paid, the income you need to declare is £1000. This can often lead to errors when calculating total taxable income.
If you pay tax at the basic rate
You have no tax to pay on your dividend income because the tax liability is 10% – the same amount as the tax credit – as shown in the earlier tables.
If you pay tax at the higher rate
You pay a total of 32.5% tax on dividend income inclusive of tax credit where this falls above the basic rate Income Tax limit (£31,865 for the 2014 to 2015 tax year). In practice however, you owe only 25% of the dividend paid to you after the tax credit has been taken into account.
If you pay tax at the additional rate
Between 6 April 2010 and 5 April 2013 you pay a total of 42.5% tax each year (37.5% from 6 April 2013) on dividend income that exceeds the higher rate Income Tax limit (currently £150,000) because the first 10% of the tax due on your dividend income is already covered by the tax credit.
Final or Interim
When approaching the financial year end, the subtle, but critical distinction between a final or interim dividend may mean the difference between paying an effective rate of tax at 0% versus 25%!
Contact us so that we can assist you in maximising your allowances in the current financial year and to minimise the amount of tax to be paid on dividends in future financial years.
From a company’s point of view timing of dividends is not critical, but from the individual shareholders perspective, timing can be an important issue.
If the shareholder is a higher/additional rate taxpayer, a dividend payment which is delayed until after the tax year ending on 5 April may give the shareholder an extra year to pay any further tax due.
The deferral of tax liabilities on the shareholder will be dependent on a number of factors. Please contact us for detailed advice.
Reporting dividend income on your self-assessment may present challenges. It is essential you report the correct dividend income, which is not the same as the cash received. You also need to ensure the income is reported in the correct period. As stated above, interim dividends will be based on payment-received date, this can often be some time after a dividend is declared. Get this wrong and your tax position can change dramatically. Leading up to the financial year-end, if you are not discussing dividend payments with your accountant, you could be paying more tax than required.
How we can help
Tax savings can only be achieved if an appropriate course of action is planned in advance. It is therefore vital that professional advice is sought at an early stage. We would welcome the chance to tailor a plan to your specific circumstances. Please do not hesitate to contact us:
t. +44 207 712 1684