New Tax Rules Affecting Company Distributions

In previous years it has been financially advantageous for business owners and directors to take a small salary during the year, and take a lump sum dividend at its end. This is because the rates of dividend tax have been much less than the rates of income tax. From 6 April 2016, however, this changed and dividend tax has been raised.

The first £5,000 is tax free, at zero rate. After that the basic rate amount is taxed at 7.5%, but the higher rate tax amount is 32.5% and for the additional rate it is 38.1%. So there is now much less advantage in taking high dividends instead of salary.

Government Concerns About Taking Capital on Winding up

Capital gains tax is also much less than income tax and now is less than both income and dividend tax. The maximum is 28% but it can be as little as 10% if an individual is eligible for entrepreneurs’ relief.

It is therefore tempting to take as much as possible as capital, which you might be able to do on winding up a company. But the government is wise to this and has set up new rules designed to discourage it. In certain circumstances they will tax such a distribution as income tax.

What Are Those Circumstances?

Firstly, the rule will apply if you are classed as a closed company, ie. one which only has up to five shareholders, or where the directors have full control of the company. Secondly, it will apply if a shareholder is paid capital from surplus reserves following a winding up, but they are involved with a new company set up for the same purpose within two years. When this is discovered the individual will be billed for extra tax, probably plus penalties.

The government takes a dim view of companies dissolved with new ones set up just to avoid higher rates of tax. They will always charge income tax on capital extracted in such circumstances.

What About Deliberately Retained Profits?

The practice of retaining profits instead of issuing dividends, so that they can be taken later as capital on winding up, has also been nipped in the bud. In future it will be penalised so you need to have a good reason for retaining profits.

Beware any tax adviser who recommends these dodgy tax avoidance schemes. Your local bookkeepers can assist you to stay within the law. They will also help you to document any legitimate reasons for retaining profits and to keep adequate records in case there are queries from HMRC.

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