Dividends - maximising your cash-flow advantage

Dividend tax

Once upon a time, HMRC taxed director shareholders on their share of profits, even where they were left in the company. But these days it can only get its hands on your loot when you take income as salary, benefits or dividends. The latter is not only the most tax efficient but also means you delay when it’s payable.

Tax timing - in theory

Dividends, even those from your own company, count as taxed investment income. For example, if you receive a dividend of £9, HMRC treats this as £9 income net of £1 tax paid. On top of the £1 tax, known as a tax credit, HMRC wants another £2.25 if you’re a higher rate taxpayer, or £2.75 if you pay at the additional rate. This extra tax is usually payable through self-assessment (SA) on the 31 January following the tax year.

Example. Barry is a shareholder of Acom Ltd and a higher rate taxpayer. On 30 April 2013 Acom paid him a dividend of £45,000. With the tax credit added this equals £50,000. Barry’s tax bill is 22.5% of this, i.e. £11,250, payable on 31 January 2015. If in the 21-month interim period Barry invested the tax money in a savings account and receives, say, 2.5% net interest, he’ll earn £500, some of which he wouldn’t have got had he paid the tax sooner.

Tax timing - in practice

In practice, HMRC has a couple of tricks to stop directors like Barry gaining a cash-flow advantage:

Coding. HMRC often adjusts director-shareholders’ code numbers so the extra tax due on investment income, e.g. dividends, is collected from their salary in the form of PAYE tax.

Tip. You can insist HMRC removes the adjustment from your code. You’ll need to appeal against your code number to do this (see The next step ).

Payments on account. Where the extra tax you owe on dividends, plus that payable on other income not taxed through PAYE, is more than 20% of your overall tax liability, HMRC can ask you to make payments up-front. These are known as payments on account.

Example. Gary is a director of Bcom Ltd. His pattern of income has been similar for years and in 2013/14 he receives £36,000 in dividends, plus salary of £40,000. The tax on Gary’s salary is £6,110 and £8,673 on his dividends. Therefore, over 20% of his total tax liability (£14,783) relates to dividends. So instead of the £8,670 being due in January 2015, he has to make payments on account on 31 January and 31 July 2014.

Tip. Payments on account for one year are based on the tax position of the previous year, unless you expect the current year’s bill to be less. So by alternating high and low dividends from year to year Gary can avoid SA payments on account altogether. It’s a little tricky to get your head around how this works in practice, so we’ve provided a couple of examples that will help (see The next step ).

For information on how to appeal against your code number (CD 14.03.04A) and for examples of how to avoid SA payments on account (CD 14.03.04B), visit http://tipsandadvice-companydirector.co.uk/download .