Maximise use of your basic rate tax band

I originally posted this article on the a4uforum in March 2007, and have updated it for the current tax thresholds.

As you know the end of the tax year is fast approaching and now is the time to consider maximising the use of your basic rate band. This can be done by declaring interim dividends to take your total taxable income upto the maximum at which the basic rate will still apply.

As dividends have a 10% tax credit attached, this tax credit can be used to effectively pay your personal tax liability on the dividend.

However, if you are a higher rate tax payer you will have additional tax to pay of 25% of the net dividend, so you may wish to delay the dividend until after 5 April.

For the tax year 2008/2009 the basic band is £34,800 of taxable income. ie ALL income and benefits in kind minus your personal tax allowance.

Tax rates and allowances are here:
http://www.hmrc.gov.uk/rates/it.htm

Dividends are payable out of after-tax profits

Dividends can only be paid out of the company’s retained profits which are the company’s profits after tax (in most cases the tax charge would be 21% of the taxable profit [between 1 April 2008 and 31 March 2010]). If you are a new company which has not yet prepared accounts, make sure that you have sufficient after tax profits with which to pay the dividend.

Bear in mind that under standard accounting principles income is taxable when earned even if not paid/received at that date. For example, commissions earned in Feb may not be received until April/May but are treated as income for Feb. This may mean that you have sufficient profits after tax to pay a dividend but not enough cash [see below]. Expenses charged in arrears which are not invoiced or paid until later should also be taken into account (for example, Google PPC advertising).

How to complete the dividend voucher

Under Company Law and income tax rules, the company must officially declare the dividend in a board minute and also issue a tax voucher to the shareholder certifying the tax credit on the dividend.

For those of you who do not have these documents, I have made templates available (Word docs):

Blank directors meeting minute ~ http://hrbs.biz/id?5
Blank dividend voucher ~ http://hrbs.biz/id?6

The dividend calculations are:

Tax credit = dividend/9
eg £9k net dividend, tax credit = £1k
ie gross dividend = £10k (this is included within your total income)
The £9k and £1k are to be shown on the dividend voucher

You will need to add your company name/address (header), registration number (footer), dividend amounts, director’s names, shareholder name/address. The templates assume meeting date and dividend date of 31 October 2008.

Loan the dividend back to your company

If the company does not have sufficient funds with which to pay the dividend in full then the dividend (net amount) can be loaned back to the company (in whole or in part) by transferring to the director’s loan account. It can then be withdrawn at a later date tax free, as the dividend has already been “paid” for income tax purposes.

For example,

Net dividend £9k
Cash paid to director/shareholder £3k
Balance loaned by director/shareholder to company £6k

The £6k can be withdrawn when the company’s cashflow permits (ie when the commissions are received).

Assuming the company has sufficient after tax profits, declaring dividends so that your taxable income is just below the higher rate tax threshold is a good way of extracting profits from your company in a tax efficient way.

Contact us to discuss how we can help you and your business.

At HRBS, pre-year end dividend planning is one of the services we offer to all limited company clients and is included in our fixed fee packages.

Call Keith on 01226 379000 for a free consultation or email us for a free, no obligation quotation.