Can dividends be drawn too often?
Contractor's Question: I am an IT contractor running my own limited company, outside IR35. Can I declare a dividend and pay it to the shareholder(s) in parts, to avoid drawing dividends too often? For example, taking a dividend of £10,000 on October 1, 2009, could I pay myself, the sole shareholder & director £3,000 on November 1st; £3,000 on December 1st and £4,000 on January 1st 2010?
By doing this, I hope to avoid declaring dividends too often, which I fear can look suspicious in the eyes of HM Revenue & Customs. Am I right to be concerned at the frequency of drawing dividends?
Expert's Answer: The frequency with which dividends are declared is much less important than whether they are legal or not.
Under the Companies Acts the prime factor here is whether the company has sufficient reserves to cover the dividend. Taking the example of the £10,000 dividend declared on October 1st, this can only be a legal dividend if the director satisfies himself that the company has sufficient reserves to cover the entire dividend at the time when it is declared. This will be an issue for the many companies where no reserves of profit have been accumulated and fees received are paid out regularly to meet the owner's income requirements.
Another consideration is that even a business owner who is the sole shareholder/director needs to take the decision as a director, i.e. considering whether it is in the interests of the company to pay out the dividend. Paying dividends without regard to the company's future needs, e.g. to meet its liabilities, including corporation tax, is a potential breach of the Companies Acts.
So if the company has reserves it can declare a single lump sum dividend and the shareholder/director can draw down the dividend at will. The taxation of the dividend depends on whether the dividend is:
a) interim, i.e. provisional, based on profits that are yet to be recorded in finalised accounts; or
b) final, i.e. based on the profits shown in finalised accounts.
Interim dividends are taxed when they are paid or when the accounts are finally approved. As well as when cash is transferred, a dividend is paid when it is credited to the director/shareholder's account with the company or another action is taken which indicates that the money has been put at the disposal of the shareholder.
Final dividends are taxable in full, as soon as they are declared to be payable because they create a debt from the company.
If that test can be satisfied, there is no objection to making frequent dividend declarations but care is needed to ensure that all the Companies Acts formalities are observed. If the formalities are not observed the company runs the risk of creating:
a)) loans to the director which may result in;
1) benefit in kind charges if the amount lent exceeds £5,000 at any time in a tax year; and
2) a charge under section 419 of the Income and Corporation Taxes Act 1988 which requires the company to pay HMRC an amount equal to 25% of the amount of any participator loan that remains outstanding more than 9 months after the end of the accounts period.
The expert was George Bull, partner at Baker Tilly.
Expert's Answer : I hope you are, in fact, right about your IR35 status! From an IR35 perspective, HMRC would not actually know the frequency that dividends have been paid throughout the year unless they inspected the records. End of year documentation would show the total dividend paid and HMRC can now quickly identify whether there is a potential IR35 issue with the answers on the returns. So in this case, they would know this is a service company and income has been treated as outside IR35.
I would suggest that it is the total amount of dividends paid over the year that would put the contractor onto HMRC's radar and more likely to be selected for investigation i.e. the more tax/NIC potentially at stake, the more likely an investigation.
The expert was Kate Cottrell, founder of Bauer & Cottrell , an employment status adviser.