Date posted: 4th Nov 2022
Many owner-managed businesses will pay dividends as a form of remuneration to director-shareholders, as this can be tax efficient (although there are instances where it is not!).
However, where the plan is to pay a dividend to the director-shareholder, the company must ensure that set procedures are in place, as there are some traps for the unwary which can lead to both commercial and tax consequences.
Firstly, the company must have sufficient reserves (after tax profits) to pay dividends to shareholders. The dividends are usually paid in proportion to the shareholdings, unless there are alphabet shareholdings in place and the articles structured correctly.
Where a dividend is paid to a class of shareholders but some waive their entitlement, there must be sufficient reserves to have paid the full amount ignoring the waived amount. A lack of reserves can lead to a host of tax implications both personally and for the company.
The relevant date for an interim dividend is either the actual date of payment or the date the payment is placed at the shareholder’s disposal. However, unless a resolution is signed and dated, HMRC will consider the payment date to be the date that the payment is entered into the company’s books.
This could be a problem if the year of declaration is a tax year when the shareholder is a basic rate taxpayer but through poor record keeping the dividend is taxed in the next year when the shareholder may be a higher rate taxpayer.
This ‘trap’ is more likely to occur in respect of an interim dividend because a final dividend only becomes an enforceable debt when approved by resolution at a general meeting of shareholders. Therefore the relevant date for a final dividend is the date of declaration, the date for which can be planned.
Income in the form of dividends together with a low or nil salary could cause problems should the director claim under a Permanent Health Insurance policy.
Such policies invariably pay out only on a percentage of earnings when the policyholder cannot work through illness or accident. Therefore it is recommended that the policy be reviewed to check that account is taken of dividend income as well.
HMRC has been known to investigate disparities between dividends declared on a personal tax return with shareholdings declared at Companies House, raising penalties for incorrect returns. Proof in the form of a paper trail of dividends declared and share certificates can be vital as the recent tax case of Terence Raine v HMRC 2016 UKFTT 0448 (TC) showed.
The company, of which Mr Raine and his colleague were directors, was set up by an agent. They were under the impression that each was holding one share and one would be appointed as the director and the other the company secretary.
However, the paperwork was completed such that, technically, one share remained in the agent’s name. For 10 years, Annual Returns (now ‘Confirmation statements’) were submitted to Companies House which showed that Mr Raine held all the shares and the accounts confirmed this. Every year, dividends were declared and paid with supporting counterfoils showing an equal split of share ownership. Eventually, HMRC checked the dividends declared against those shareholdings shown on the Annual Return and saw that they differed. The tax tribunal concluded that Raine must have been aware of the discrepancy, as he was the director who had signed the accounts. Therefore the tax demand and penalties that would have been paid as per the paperwork (namely, all taxable on Raine) were valid.
If the paperwork is poor then HMRC could decree that any non-payroll payments are loans and thus repayable to the company rather than being dividends. Similarly a liquidator looking into the company’s affairs, may also decree that the amounts paid are loans, especially if the liquidator needs to settle any amounts owed to creditors. A liquidator could therefore require the shareholders to repay loans to the company. This could be disastrous, especially as many businesses are likely to face uncertain times going into 2023 due to the state of the economy.
If you have any queries regarding remuneration planning, please give us a call.