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Drawing Dividends

It has now become quite common for small businesses to be formed into limited companies to save on National Insurance.  The formula is simple – the owner is both director and shareholder.  By taking a low salary, this leaves more in the pot to pay out as dividends.  Whilst the salary attracts NIC, dividends do not, so keeping the salary low avoids unnecessary NIC. 

It is not ideal for everyone – administration costs are higher and the penalties for getting things wrong are greater, but for those prepared for the extra work, who keep on top of it, there are savings to be made.

However, the Inland Revenue are on the case.  They are challenging the dividends in more cases, claiming that they are salary unless it can be proved otherwise.  The ‘proof’ needed is a clear indication on the part of the director, at the point when the dividend is paid, that it was in fact a dividend.  Case law is patchy and a cheque stub saying ‘dividend’ is arguably evidence, but they are starting to ask for minutes of directors meetings to approve the dividends and dividend counterfoils.  Click these links or the buttons to see examples of minutes for regular dividends or single dividend

It is therefore more important than ever that any amounts drawn from the company must be for a specific item, such as salary, dividends, etc., and should be drawn separately from each other, not as one lump sum. 

 The only amounts that may be drawn from the company are:-

bulletNet salary
bulletDividends out of profits (remembering to leave 21% in the company, to pay the corporation tax)
bulletReimbursed expenses (such as mileage allowance)
bulletRepayment of amounts loaned to the company by the director.

Remember – unless it’s one of the above, it’s the company’s money, not yours!

'Income shifting'

Following the defeat suffered by HMRC in the House of Lords 'Arctic Systems' case, they are now simply trying to move the goal posts.  They want to be able to challenge any situation where shareholders get dividends that are disproportionate to the profits that they generate.   In short, if Mr Smith does most of the work, then Mr Smith will be taxed on most of the dividends, irrespective of the shareholdings or any other factors.

Legislation was being lined up for Spring 2008, but representations from various bodies has delayed this - however, it is only a matter of time...

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