Practice Marketing August 2019 – Business Articles
Two business tax articles:
Timing Dividends right could help save tax
Timing the date of a dividend payment from a company can determine both the amount and the due date of the tax payable. This may be a particularly useful strategy in a close- or family-owned company.
The dividend allowance, which was originally introduced from 6 April 2016, was cut from £5,000 a year to £2,000 from 6 April 2018. Fortunately, the tax rates on dividend income, above the allowance, remain at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
The amount of tax payable on dividend income is determined by the amount of overall income an individual receives during a tax year. This includes earnings, savings, dividend and non-dividend income. The amount of dividend tax paid depends primarily on which tax band the first £2,000 falls in.
The timing of the dividend payment may have a marked impact on the directors’ and shareholders’ personal tax situation. A dividend is not paid until the shareholder receives the funds direct or the dividend amount is put unreservedly at his or her disposal, for example by a credit to a loan account on which the shareholder has the power to draw. If the personal tax allowance and basic rate band for a tax year have not been fully utilised towards the end of the tax year, payment of a dividend may mean that the unused portion can be mopped up.
Graham is the sole director and shareholder of a limited company.
He is considering whether to pay a dividend before the end of the 2019/20 tax year. In that tax year he has other income of £25,000. He has retained profits in the company of £100,000.
For 2019/20 the personal tax allowance is £12,500 and the basic rate tax band is £37,500. The dividend allowance is £2,000.
If Graham pays a dividend of £27,000 before the end of the 2019/20 tax year, he will fully utilise his basic rate band, and will be liable to tax at 7.5% on the £25,000 of the dividend income (the first £2,000 of the dividend being covered by the dividend allowance).
Where the shareholder already has income exceeding the basic rate band in one tax year, delaying the dividend until the start of the next tax year could save tax.
Following on from the above example, say Graham has already paid himself a salary of £50,000 in the 2019/20 tax year, thus fully using up his basic rate band. If he pays the £27,000 dividend before the end of the tax year, he will pay tax on it of £8,125 (£27,000 – £2,000 allowance x 32.5%). This tax will be due for payment on 31 January 2021.
If he waits until the start of the next tax year (2020/21) to pay the dividend, and also receives a salary of £25,000 during that year, the tax due on the dividend will be £1,875 (£25,000 x 7.5%) – a potential saving of £6,250. Graham will also benefit from a delay in the due date for payment of the tax until 31 January 2022.
Dividend payments can often be timed to smooth a director/shareholder’s earnings year-on-year. Broadly, where profits fluctuate, a company could consider declaring and paying dividends equally each year, or by declaring a smaller dividend in the first year (when profits are higher) and treating the remainder of the payment as a shareholder loan. At the start of the next tax year, a further (smaller) dividend can be declared, which will repay the loan. Care must be taken with this type of arrangement, not least because the loan must be repaid within nine months of the company’s year-end to avoid a tax charge arising on the company.
The family business potentially offers considerable scope for structuring tax-efficient payments to family members using a mixture of both salary and dividends. A pre-dividend review may be particularly beneficial towards the end of the company’s year-end.
Partner Note: ITA 2017, s 8 and s 13A; F(No 2)A 2017, s 8; CTA 2010, s 455
Self-employed or run a business? Read how to time dividends to save tax. #selfemployed #entrepreneur #businesstax
If you need help on how to time dividends, read our short article that explains the basics.
Optimising tax-free benefits in family companies
Making use of statutory exemptions for certain benefits-in-kind offers an opportunity to extract funds from a family company without triggering a tax charge.
The essential point to note is that to make the tax saving, the benefit itself, rather than the funds with which to buy the benefit, must be provided.
No tax charge arises where an employer provides an employee with a mobile phone, irrespective of the level of private use. The exemption applies to one phone per employee.
A taxable benefit will however, arise if the employer meets the employee’s private bill for a mobile phone or if top-up vouchers are provided which can be used on any phone
John and Jan Smith are directors of their family-owned company. Their two children also work for the company. The company takes out a contract for four mobile phones and provides each member of the family with a phone. The bills are paid directly to the phone provider by the company. The bills are deductible in computing profits. Each family member receives the use of a phone tax-free, which means they do not need to fund one from their post-tax income.
Pensions remain a particularly tax-efficient form of savings since nearly everyone is entitled to receive relief on contributions up to an annual maximum regardless of whether they pay tax or not. The maximum amount on which a non-taxpayer can currently receive basic rate tax relief is £3,600. So an individual can pay in £2,880 a year, but £3,600 will be the amount actually invested by the pension provider. Higher amounts may be invested, but tax relief will not be given on the excess. Any tax relief received from HMRC on excess contributions may have to be repaid.
Pension contributions paid by a company in respect of its directors or employees are allowable unless there is an identifiable non-trade purpose. Contributions relating to a controlling director (one who owns more than 20% of the company’s share capital), or an employee who is a relative or close friend of the controlling director, may be queried by HMRC. In establishing whether a payment is for the purposes of the trade, HMRC will examine the company’s intentions in making the payment.
Pension contributions will be viewed in the light of the overall remuneration package and if the level of the package is excessive for the value of the work undertaken, the contributions may be disallowed. However, HMRC will generally accept that contributions are paid ‘wholly and exclusively for the purposes of the trade’ where the remuneration package paid is comparable with that paid to unconnected employees performing duties of similar value.
Other tax-free benefits
Subject to certain conditions being satisfied, other tax-free benefits that a family company may consider include:
Employing family members, and providing them tax-free benefits, often enables a family-owned company to take advantage of the lower tax rates, personal allowances and exemptions that may be available to a spouse, civil partner, or children. In turn, this arrangement can help reduce the household’s overall tax bill.
Partner Note: ITEPA 2003, s 244, s 308C, s 319; BIM46035, BIM47105
Run a #familybusiness? This is how to reduce your overall #tax bill:
Make sure to share this article with anyone you know who runs a family business – so they can take advantage of the many ways to lower their tax bill!