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Maximise use of your basic rate tax band guide to maximising the use of your basic rate band Maximise use of your basic rate tax bandI originally posted this article on the a4uforum in March 2007, and have updated it for the current (2015/16) tax thresholds.

I recommend to all our clients that they maximise the use of their basic rate band. This can be done by declaring interim dividends to take total taxable income up to the maximum at which the basic rate will still apply.

As dividends currently have a 10% tax credit attached, this tax credit can be used to effectively pay the basic rate personal tax liability on the dividend. This is why they are known as “tax free” dividends. Higher rate and additional rate tax payers will have extra tax to pay which is usually collected via self assessment and so they would need to register for self assessment and submit a tax return to HMRC to report the income and tax liability.

Please note that the 10% tax credit is to be abolished from 6 April 2016 and this guide is for the current (2015/16) income tax year only.

For the tax year 2015/16 the basic rate band is £31,785 of taxable income. ie ALL income and benefits in kind minus your personal tax allowance. The 2015/16 tax year runs from 6 April 2015 to 5 April 2016.

We have the income tax rates and allowances in our free app for Android here and for Apple here.

The free app also has lots of useful calculators and guides.

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 making an allowance for the tax payable on the profits (in most cases the tax charge would be 20% of the taxable profit). These are known as the company’s distributable profits.

For example, a company making £50,000 taxable profit before tax would typically have a corporation tax bill of £10,000 (20% x £50,000) leaving £40,000 as distributable profits for the period. If the company did not have brought forward losses, all of the £40,000 could potentially be paid (declared) as dividend. In reality, an established company may have brought forward profits or losses from an earlier period, both of which would affect the actual dividend available to pay to the shareholders.

Dividends are an often misunderstood part of UK company and tax law, particularly for those new to running their own company. Sometimes dividend decisions are made based on the funds in the bank, not on the company’s after-tax profits. It is strongly recommended that you prepare interim accounts and calculate the tax payable to HMRC on the profit so that you know that you have sufficient after tax profits with which to pay the dividend. Otherwise they will be partly or wholly void and repayable to the company with potentially expensive tax consequences for both the company and the director/shareholder.

The dividends are paid to the shareholders in the ratio of their shareholdings. For example, where a total dividend of £10,000 is paid to shareholders who own 25% and 75% respectively of the ordinary shares, the dividend would be payable £2,500 to the 25% shareholder and £7,500 to the 75% shareholder.

Also bear in mind that the company does not need to pay all of its distributable profits to the shareholders. Where the directors and shareholders are the same people, they would be able to decide when to take dividends to suit their own personal tax planning arrangements or where the business’ profits fluctuate from year to year and the shareholders wish to keep their personal income consistent.

How to complete the dividend voucher

Under Company Law and current 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. The voucher is the shareholder’s proof of receipt of the dividend (and the tax credit) and needs to be kept in case of a HMRC investigation into the shareholder’s personal tax affairs.

(Common reasons for HMRC investigations include not ticking the student loan box on a self assessment tax return, not declaring rental income when moving into a partner’s home and renting old the old home, and omitting from the tax return interest received on a bank account closed during the tax year).

If you do not have the dividend documents, feel free to download our Microsoft Word templates:

The current dividend calculations are:

Tax credit = dividend/9
eg £9,000 net dividend, tax credit = £1,000
ie gross dividend = £10,000 (this is included within your total income)
The £9,000 and £1,000 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.

Loan the dividend back to your company

If the company does not have enough money to pay the dividend in full, or wishes to keep the money in the bank, 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. The gross dividend is included in the shareholder’s taxable income when the dividend is declared (part paid in cash and balance added to the loan account) not when the loan is paid.

For example,

Net dividend declared (as shown on the voucher) £9,000
Cash paid to director/shareholder £3,000
Balance loaned by director/shareholder to company £6,000

The £6,000 can be withdrawn at a later date when the company’s cashflow permits (eg 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 currently a good strategy of extracting profits from your company in a tax and National Insurance efficient way.

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

At HRBS, pro-active dividend planning is one of the many 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.

This guide updated October 2015