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Maximise use of your basic rate tax band

hrbs.biz 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 (2019/20) tax thresholds.

I recommend to all director/shareholder clients that due to the tax changes in recent years they maximise the use of their basic rate band where possible. 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. If they do not need the funds, they can loan the dividend back to the company as explained later in this article.

The current (2019/20) tax rates on dividends are:
0% on first £2,000
7.5% for basic rate tax payers
32.5% for higher rate tax payers
38.1% for additional rate tax payers

For the tax year 2019/20 the basic rate band is £37,500 of taxable income. ie ALL income and benefits in kind minus your personal tax allowance (£12,500). The 2019/20 tax year runs from 6 April 2019 to 5 April 2020.

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 19% 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 £9,500 (19% x £50,000) leaving £40,500 as distributable profits for the period. If the company did not have brought forward losses, all of the £40,500 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 for mortgage applications.

The dividend voucher

Under Company Law and current income tax rules, the company must issue a tax voucher to the shareholder stating the amount of the dividend. The voucher is the shareholder’s proof of receipt of the dividend and needs to be kept so that they have a record of dividends received for their personal tax return.

Loan the dividend back to your company

If the company does not have enough cash to pay the dividend in full, or wishes to keep the money in the bank, the dividend can be loaned back to the company (in whole or in part). It can be withdrawn at a later date tax free, as the dividend has already been “paid” for income tax purposes. This is usually when the shareholder is also a director. The dividend is included in the shareholder’s taxable income when the dividend is declared not when the loan is repaid.

For example,

Dividend declared (as shown on the voucher) £10,000
Cash paid to shareholder £4,000
Balance loaned by shareholder to company £6,000

The £6,000 can be withdrawn at a later date when the company’s cashflow permits (eg when the affiliate marketing 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.

[article updated 01 August 2019]

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