PROFIT EXTRACTION - 24.01.2018

Planning for the year end with owner managers

Changes

Traditionally, February is a good time to start looking at your clients’ profit extraction ahead of the end of the tax year. The returns have (hopefully!) all been submitted, and there is something of a lull before the P11D filing begins that gives you the opportunity to be proactive.

For 2018/19, the dividend allowance is falling from £5,000 to just £2,000. Above the allowance the dividend tax rates bite hard at 7.5%, 32.5% and 38.1%, depending on whether the dividends fall into the basic, higher or additional rates respectively.

Pro advice. Check whether your clients’ profits for the year would enable them to accelerate dividend payments to fall before 6 April 2018 to take advantage of the £5,000 allowance. Remember this will be even more valuable for companies with two director shareholders who are spouses.

Remember also that the fall in the corporation tax rate to 19% from April 2017, and the scheduled further drop to 17% scheduled for 2020, will help offset the the reduced allowance slightly. In addition, because of the way the dividend allowance uses up the tax bands, clients who take a small salary topped up with dividends will be able to apply more basic rate band to the excess dividends than previously.

Let’s have a look at some dangers to avoid with dividend planning.

Interim dividends

Interim dividends must be declared at a board meeting, and before declaration a review of the company’s finances must be carried out to establish that the dividend can be met out of profits. It is imperative that the decision to declare an interim dividend is recorded in contemporaneous minutes.

Pro advice 1. Directors need a paper trail proving proper regard to company profitability. Printing out a trial balance as evidence makes a good start.

Pro advice 2. Make sure clients appreciate dividends should be paid or credited to directors’ loan accounts at the time, not retrospectively when it is time to complete the tax return!

As far as HMRC is concerned, an interim dividend is paid when the director can use it. Significant problems can arise if you depart from procedure. HMRC can seek to reclassify such payments, for instance as employment income. There could also be the possibility that dividends are required to be repaid.

Profitability

Distributions made when there are not sufficient distributable profits within the company could result in a charge of ultra vires. Where a company is in financial straits, directors could be made personally liable to repay the dividends.

If an ultra vires dividend is used to cover an overdrawn director’s loan account, the loan account would remain overdrawn, and both company and director could be faced with a bill: the company for a s.455 Corporation Tax Act 2010 charge on loans to participators, payable at the dividend upper rate of 32.5%; the director for a benefit in kind charge on a beneficial loan.

Insolvency

HMRC is increasingly concerned about companies and directors failing to pay taxes due to insolvency. One weapon in HMRC’s armoury is raising tax bills on directors of failed companies, or requiring ultra vires dividends or overdrawn loan accounts to be repaid.

In Parmar v HMRC [2016] TC04927 (see Follow up ) this was taken to new heights by treating undeclared cash income of a company as salary, and charging the directors personally for tax and NI due. The accountant’s argument that all profit extraction was by way of dividends was rejected as there had been no directors’ meetings at, or resolutions in, which any of these amounts had been declared as dividends. This underlines the need for a paper trail.

Digital trap

In the past, limited companies may have been careless with procedure as to declaring and paying dividends but haven’t run aground as a result. Some clients may have slipped into the habit of writing directors’ meetings up retrospectively at the end of the year.

But with digital technology, business information is becoming more visible to HMRC. One recent Tribunal case, Baloch v HMRC [2017] TC06092 (see Follow up ), regarding a locum doctor suggests the way that things are moving.

Here, the taxpayer purported to have held a director’s meeting, but from other evidence, such as time records, HMRC was able to prove that he was somewhere completely different. Unreliable records prepared some time after the event showed discrepancies between the company’s records and returns and the director’s.

Once digital submission of VAT records for Making Tax Digital is underway from April 2019, HMRC will have more than time records to go on. There will be access to real time information about your clients’ businesses direct from the accounting records, so there will be a time-stamped digital footprint for almost all entries.

Pro advice. Clients may be wary of declaring dividends in year in case they accidentally declare them in excess of distributable reserves. However, if good management accounts are being kept, there is no real reason that accurate estimates can’t be made, particularly towards the end of the year.

Final dividends

Final dividends should be declared at the annual general meeting. Once a payment date has been declared, HMRC considers that they are the income of director shareholders from the date that they have a legal right to them. This provides a planning angle: dividends can be declared but paid later. This also means clients can maximise the cash-flow advantage with scope to delay payment.

Pro advice. If it is worthwhile, advise clients to ensure final dividends are declared and due in the 2017/18 tax year. Even if cash flow means they want to delay making payment, they can still push the dividend into the earlier tax year.

Remuneration planning

Plan now for tax efficient 2018/19 remuneration packages. Consider charging interest on sums lent by directors, or charging rent for property owned by a director and used by the company.

Advise director clients to make full use of benefits in kind, trivial benefits and pension exemptions. If the trivial benefits limit for this year - £300 with a limit of £50 per trivial benefit - has not been used up, take advantage now. Watch out for the impact of NI, too. NI contributions are only due on earned income, not on rent, interest, or dividends meaning savings are to be had, albeit minor ones.

Managing the rate

If income fluctuates, consider leaving profits in the company to be taxed at 19% rather than face high income tax rates on dividend withdrawals. Avoid large profit extraction one year followed by small profit extraction in the next and look to average.

Check that clients make best use of their rate bands. What is their highest rate of tax? Can it be kept down? Gift aid and pension payments can help keep clients in a lower tax band.

Scottish taxpayers should be particularly careful as the Scottish higher rate band is lower than that for the rest of the UK. The Scottish Budget on 14 December 2017 proposed increased divergence in income tax bands across the UK. Scottish income tax only applies to non-savings and non-dividend income, catching salary, pensions and rental income but not interest or dividends.

Parmar v HMRC [2016] TC04927

Baloch v HMRC [2017] TC06092