Dividend payment

[DivyeshS]

Hi there,

I am contractor working through my own Limited company setup. I and my spouse both are 50% (one share each worth 1£) share holder in my company and I am the Director. My accountant has recently done the accounts for company's first account period ended 31/03/2011.

During this accouting period I have been paying myself salary and dividend every month. For all X amount of dividends I have paid everything has gone to my personal bank account. For this accounting period I haven't paid anything to my spouse as dividend/salary as I needed to achieve certain threshold level of income. I asked my accountant whether it is ok or not and he said that it's fine. He said company can pay the dividend just to you for the period and you could then document this as the minutes of a meeting for a company. From next accounting period I would be paying equal dividend to me and my spouse.

We haven't submitted accounts yet to HMRC or Companies House, so just wanted to check whether are there any issues with above sort of practice or not? Advice pls.

Regards

[Greg@CapitalCity]

Purely from the dividend payment perspective, so long as you both hold different classes of shares (ie Ordinary A, and Ordinary B), then paying different amounts of dividends against different classes is fine. If you both have the SAME class of share, then each shareholder must receive the same amount in dividends since you both hold the same number and class of shares.

[Clare@InTouch]

If you both hold shares of the same class then you should be paying equal dividends, unless one shareholder has waived their right to a dividend. You'd need the necessary dividend waivers in place to show this, and you also need to ensure you had sufficient profits to cover both dividends if the second hadn't been waived - for example if you have profits of £10,000 and paid out £9,000 to yourself then you may have a problem, because the company couldn't have afforded to pay out the full £18,000 without your spouse waiving her rights. This has been stated by HMRC to be a warning sign that (the old) section 660a may apply (it's effectively a settlement).

HM Revenue & Customs: Tax Bulletin Issue 64

There are a wide range of arrangements that can potentially be caught by the settlements legislation which do not involve a trust. Each case will depend on the facts but some of the most common situations which we see are:

Shares subscribed at par that carry only restricted rights.
Shares given away that carry only restricted rights.
Shares subscribed at par in a company by someone else where the income of the company derives mainly from a single employee.
A share in a partnership gifted or transferred below value.
Dividend waivers.
Situations where dividends are paid only on certain classes of shares.
Dividends paid to the settlor's minor children.

These lists are by no means definitive of situations to which the settlements legislation can be applied.

Example 6 - Dividend Waivers

Where a company with few shareholders declares a final dividend when one or more of the shareholders has waived their right to a dividend in circumstances where other shareholders may benefit, it is possible the settlements legislation could apply.

For example Mrs H owns 80 ordinary shares in H Limited. _Mr H owns 20 shares. In 2000 the company made a profit of £25,000. Mrs H waived her right to any dividend. The company then declared a dividend of £1,000 per share, and Mr H, who had no other income, received a dividend of £20,000.

We would apply the settlements legislation in these circumstances. Clearly a dividend of this amount could not have been paid from the company's profits on all the shares, so the waiver arrangement enhanced the dividend paid to _Mr H. £16,000 of the dividend paid to Mr H is attributed to Mrs H under section 660A because the waiver was a bounteous arrangement.

[DivyeshS]

Thanks GregCapitalCity and Clare for your prompt replies.

@GregCapitalCity - We both hold same class of share.

@Clare - Thanks for detailed explanation. How to obtain dividend waiver? Also if one of the shareholder waives his/her dividend then do company still need to have double of dividend paid as profit (in case when there are only two share holders each with 50%)?

In my case, this arrangement is not for tax effeciency. In fact I would be paying some tax as higher rate tax payer as well. Does it still bring the matter onto HMRC's radar?

Regards

[Clare@InTouch]

A dividend waiver is just paperwork, your accountant should be able to provide a template for you.

The company always has to have enough profit to pay out the full dividend to everyone. If one person waives their right to a dividend then the company just retains that profit rather than paying it out. You shouldn't pay out a dividend of £10,000 to yourself unless the company has profit available of £20,000 for example, as it would need to be able to afford to pay the other £10,000 to your wife.

The whole settlements/income shifting thing has been high on HMRC's agenda for years now, and whilst there's nothing wrong with what you've done (assuming you had profits available) it's not something we'd actively recommend.

[DivyeshS]

Alright got it. Thanks for the valuable advice Clare. Getting more and more clear with time on how to operate company effectively and without any hassle. Contractor Uk forum have been really helpful.

Regards

[lje]

Why not just declare the dividends to be half each retrospectivly and make sure the paperwork represents this? You could then say the extra money you took was a director's loan, pay it back and then pay your partner her dividends?

Having written this it sounds a bit complicated. But I wouldn't feel comfortable having a dividend waiver from one party.

[northernladuk]

In my case, this arrangement is not for tax effeciency. In fact I would be paying some tax as higher rate tax payer as well. Does it still bring the matter onto HMRC's radar?

Regards

It certainly looks like you have issued the shares for tax efficiency and the fact you haven't used it also screams the fact you haven't used it due to you not needing to evade any tax yet. From a quick check it looks pretty bad IMO. Obviously there are mitigating circumstances such as you saying you are paying higher rate of tax but to get to that level the paperwork is already on an HMRC's inspectors desk.

You also mentioned paying her a wage. Remember she has to earn this wage... every penny of it... you cannot justify 7K a year for book keeping and answering the phone.

The whole settlements/income shifting thing has been high on HMRC's agenda for years now, and whilst there's nothing wrong with what you've done (assuming you had profits available) it's not something we'd actively recommend.

I would have thought in the OP's situation it would be a much safer bet to actively discouraged the whole situation. Using waivers to retrospectively clear up a situation that from the outside looks clearly like income shifting is not a good situation by any means?

[DivyeshS]

It certainly looks like you have issued the shares for tax efficiency and the fact you haven't used it also screams the fact you haven't used it due to you not needing to evade any tax yet. From a quick check it looks pretty bad IMO. Obviously there are mitigating circumstances such as you saying you are paying higher rate of tax but to get to that level the paperwork is already on an HMRC's inspectors desk.

Share distribution is, as you said, for tax efficiency. However dividends were not paid to my spouse because I needed to achieve certain level of income for the purpose of some loan and hence paying higher rate tax too for last financial year. From next accounting period onwards i wouldn't require to achieve this level of income and hence dividend will be equally divided between both of us.

You also mentioned paying her a wage. Remember she has to earn this wage... every penny of it... you cannot justify 7K a year for book keeping and answering the phone.

I haven't mentioned paying her any wage. she will only receive dividends as being share holder of the company.

Regards

[Clare@InTouch]

I would have thought in the OP's situation it would be a much safer bet to actively discouraged the whole situation. Using waivers to retrospectively clear up a situation that from the outside looks clearly like income shifting is not a good situation by any means?

It's certainly not something I'd suggest, but without knowing the full discussion between the OP and his accountant it's hard to know if this is a retrospective adjustment, or just helping the OP understand what the accountant has done - optimistic hat on for a sec, maybe his accountant has been completing the waiver paperwork all along and has copies on file....