Tax Insight - Income Tax Planning for Company Owner Managers

posted 10 Jul 2020 2 mins

If your company’s business has been affected by the coronavirus lockdown, it’s likely that cash flow has suffered most. In the longer term, the downturn is also likely to reduce profits or even result in losses.

If in previous years the company made profits that are still shown as reserves or retained on the balance sheet, you can take them as dividends now, provided that subsequent losses have not exhausted the company’s reserves.  

A&B Ltd has generated little revenue in the last two months and since the start of the tax year its director shareholders, Alan and Belinda, have taken virtually no income. 

A&B Ltd.’s accounts for the year to 31 December 2019 showed reserves of £250,000 and interim accounts show losses for the current year of £5,000. 

Alan and Belinda expect their business to achieve a modest profit by the end of 2020 and are topping up their income from savings. 

As a result, Alan and Belinda may not make full use of their tax-free allowances and basic rate band. This arrangement, in the longer term, is not tax efficient.

Potential solution
Alan and Belinda could declare dividends out of A&B Ltd.’s reserves to use their basic rate bands. The maximum rate of tax they would pay on the dividends is 7.5%, making this a very tax-efficient way to extract some of the £250,000 profit reserves. 

While it seems counterintuitive to pay a dividend in a year when the company is struggling, it can nonetheless be tax efficient to do so.

Lack of company cash might seem a significant hurdle when paying dividends from reserves, but this is not necessarily the case. For tax purposes, the dividends are treated as paid when they are recorded in the company’s records. For director shareholders this is typically entered as a credit to their directors’ loan accounts. No cash must leave the company, so shortage of cash is no barrier to tax-efficient profit extraction.

If you have questions about any matters discussed in this Insight, please do not hesitate to contact one of the Tax team.