HMRC pursue unlawful dividends
Over recent years, HMRC have become increasingly interested in the company law elements of dividends. This is mainly due to the fact that running a business through a company and taking the profit as dividends can create substantial savings. Introducing family members as shareholders can effectively double up on these savings.
Even with the proposed changes to the tax system from next year, including the 50% additional rate and a corporation tax (CT) rate of 22% for small companies, there are still savings to be made.
Consider Anthony, who makes annual profits of £300,000 and his year end is 31 March. A comparison of his position as a sole trader or if he incorporates at the start of the 2010/11 tax year (taking a salary equivalent to the nil rate NIC threshold and the balance as dividend and using figures for 2009/10 where appropriate) is as follows:
| 2010/11 |
£ |
|
Profits before salary if incorporated |
300,000 |
|
Salary |
5,715 |
|
Dividends if incorporated |
229,542 |
|
Taxes payable: |
|
|
| |
As sole trader |
£ |
|
As company |
£ |
|
| |
Income tax |
127,520 |
|
Income tax on salary |
1,143 |
|
| |
NI |
5,739 |
|
NI on salary |
Nil |
|
| |
|
|
|
Tax on dividends |
61,332 |
|
| |
|
|
|
CT @ 22% |
64,743 |
|
| |
Total |
133,259 |
|
Total |
127,218 |
|
Extra taxes payable if unincorporated |
£6,041 |
|
However, if HMRC can show that the dividends were unlawful from a company law perspective at the time of payment, then they will argue that the money extracted was not a dividend but a loan.
For many owner managed companies, this would result in;
- a 25% corporation tax bill for the company on the amount treated as a loan - £229,542; and
- a benefit on the director shareholder, on the use of the monies, calculated currently at 4.75% for each tax year the loan is outstanding; and
- an employer NI charge on the taxable benefit for each tax year.
Overall this may result in more tax than a dividend, especially if the loan remained outstanding for some time.
Further in a recent case, the taxpayers entered into a particular corporate structure which, if it worked, mitigated the corporation tax bill greatly. HMRC said that this structure did not work. However, the companies involved did not have enough money to pay the corporation tax.
HMRC then looked back in time and saw that the owners had extracted a lot of the profit over the years as dividends. So HMRC attempted to use company law to make the owners repay the dividends on the basis that they had been paid unlawfully… which would then leave the companies involved with money to pay the corporation tax. Sneaky!
HMRC won the first two rounds of this case. Although they have lost the latest round, it just goes to show how important dotting the ‘i’s and crossing the ‘t’s can be and that for companies on an ongoing basis, they need to ensure there are enough reserves at the time of paying the dividend to cover it.
HMRC are clearly interested in this area, so if you have any concerns, please do not hesitate to get in touch.
Disclaimer - for information of users: This newsletter is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this newsletter can be accepted by the authors or the firm.
|
C o m p l e t e
Regulated
to carry on audit work for a range of investment business
activities by the Institute of Chartered Accountants in England
and Wales