The current regime for taxing dividends has been in place since 6 April 2016. Under the rules, all taxpayers, regardless of the rate at which they pay tax, are eligible for a ‘dividend allowance’. Although termed an ‘allowance’, in reality the dividend allowance is a nil rate band and dividends sheltered by the allowance are taxable at zero rate. The allowance is set at £5,000 for 2016/17 and 2017/18, enabling all taxpayers to receive dividend income of £5,000 tax-free (on top of any dividends that are covered by the personal allowance). Once the dividend allowance (and the personal allowance) have been used up, dividends are taxed at 7.5% to the extent that they fall within the basic rate band, 32.5% to the extent that they fall within the higher rate band and 38.1% to the extent that they fall within the additional rate band.
The dividend allowance is to fall to £2,000 from 6 April 2018. This will impact on anyone who received dividends, either from investments or as part of a profit extraction strategy from a personal or family company.
Dividends are popular and tax-efficient method of extracting profits from a personal or family company. Where profits are extracted in this way, it is sensible to plan ahead to ensure that the higher dividend allowance available for 2017/18 is not wasted. Where shareholders in personal or family companies have taken dividends of less that £5,000 in 2017/18, and where retained profits are sufficient, consideration should be given to paying a dividend before 6 April 2018 in order to mop up any unused dividend allowance for 2017/18. For 2018/19 onwards, the allowance is only £2,000.
Paying a dividend after 6 April 2018 rather than before may mean (depending on the size of the dividend) that it is taxable where previously it was tax-free. Assuming that dividends of at least £5,000 continue to be paid in 2018/19 (and the personal allowance is utilised elsewhere), the reduction in the dividend allowance will increase the tax payable by a basic rate taxpayer by £225, a higher rate taxpayer by £975 and an additional rate taxpayer by £1,143.
Talk to us about tax-efficient profit extraction policies and the benefits of planning ahead.
Benefits. You’ll probably want your company to provide you with as many benefits-in-kind as possible (provided your personal income tax liability is not so large that it would be cheaper for you to purchase the item in question yourself). There can be advantages in a whole host of goods and services being provided by your company. Yes, there will be an income tax charge on you to cover the private element of the benefit, but this is often less than the real market value of having the benefit.
Example: A higher rate tax paying director wants to purchase goods costing £900. He would need £1,552 of gross salary, whereas he would be charged income tax on £900 (tax = £360) if the company provided the item.
Care needs to be taken with this philosophy and a cautious approach would be needed for the company to concentrate on first buying those goods which are connected with its trade and which you would have had to purchase personally if the company did not do so.
Expenses. You’ll want your company to meet the cost of all expenses which have a business connection or relationship, no matter how remote that connection might be. Although you can claim tax relief under the general rule for those expenses that are “wholly, exclusively and necessarily” incurred in the performance of your duties, this is notoriously restrict terminology. From a tax avoidance point of view it’s generally sensible to arrange that the company meets all expenses (directly or by reimbursement) which would not have been incurred but for the existence of the duties in question.
What are the common risks HMRC review in a set of accounts?
Beginning with turnover figure, HMRC will critically analyse:
- The sales figure itself. Now that HMRC received reports from the merchant acquirers who process credit/debit card transactions, the turnover declared by businesses can be tested more thoroughly. For example, if a business that trades predominantly in cash, such as a retail shop, declared a turnover of £100,000 and HMRC knows £96,000 was generated from card transactions, how credible are the annual accounts if a maximum of £4,000 in sales were paid for by cash? In that situation, the turnover declared would be considered to be a risk. Another example is the business which trades just below the VAT threshold limit year after year. HMRC would consider the turnover declared by that business to be a risk as well.
- Stock valuations. HMRC has always checked to make sure that stock is valued correctly in year end accounts. If the figure appears to be estimated year after year, rather than valued at the lower of cost or net realisable value, that is a potential risk.
- Expenditure claims. HMRC does not just attempt to see if personal use adjustments have been made, perhaps for own consumption by the pub landlord or restaurateur, but will also want to see that the business owner has understood the difference between revenue and capital expenditure. Other issues for concern usually involve the writing off of bad debts too soon and wags payments to family members.
- Balance sheet entries. Again, cash is a crucial factor. HMRC will look to see if the cash on hand figure appears to be an actual or estimated figure. A complete lack of cash on hand is usually always classed as a risk by HMRC because most businesses will need a petty cash float, even if it is just to pay for the window cleaner.
- Director’s Loan Account. If HMRC is looking at a Limited Company, the Director’s financial affairs invariably attract attention. An overdrawn Director’s Loan Account is always of concern to HMRC, as is the absence of any adjustments to reflect expenditure paid by the company on behalf of the Director.
There are a whole host of factors which feature in a business risk assessment and the list above simply gives an indication of the most common risks which trigger enquiries.
The risk assessment of an individual’s self-assessment tax return is altogether different. If someone received money as an employee or a business owner, that money is either going to be spent or saved, so HMRC will look at that individual’s lifestyle and check to see whether assets, such as a property or shares have been acquired, or if the money has been saved into a bank or building society account.
HMRC look to see if the lifestyle picture stands up to scrutiny based on the details contained within the tax return and the information it receives from third parties. If HMRC has received information about an asset or an account which has not been declared, an enquiry is likely to follow.
The very final category is the random enquiry which, by its sheer nature, is impossible to predict.
All enquiries begin with a formal letter from HMRC, but what triggers the issue of the letter?
HMRC conducts risk assessments of particular groups of individuals and businesses and then launches campaign activity. Voluntary disclosures are invited by HMRC from the selected group initially, but once the opportunity to come forward has passed, enquiries begin and favourable settlement terms are withdrawn. HMRC’s current high profile Let Property Campaign is focused on landlords, but the Second Incomes Campaign directed at employees who receive untaxed income and the Credit Card Sales Campaign, centred on individuals and businesses who accept credit and debit card payments, remain open as well.
Geographical risk assessment by HMRC can often lead to taskforce activity. More than 140 taskforces have been initiated since 2011, delivering more than £404m. This includes £109m brought in during the first six months of 2015/16. The latest taskforce announced is targeted on adult club owners and adult entertainers. HMRC believes the adult entertainment industry could be worth up to £5bn and is keen to clampdown on those failing to pay the correct amount of tax.
Aside from campaign and taskforce activity, HMRC selects individuals and businesses for enquiry based on entries made on tax returns and from third party information held.
Tax gap by type of tax
The current tax gap is estimated to stand at just shy of £34bn:
Income Tax, National Insurance Contributions and
Capital Gains Tax £14.0bn
Corporation Tax £3.0bn
Excise duties £2.7bn
Other taxes £1.1bn
As the largest proportion of the gap is due to income tax, national insurance contributions and capital gains tax, HMRC focuses its attention on small and medium enterprises and individuals who make mistakes with their accounts or simply fail to take reasonable care in checking that their tax returns are accurate and complete.
The £14.0bn figure is broken down as follows:
Self Assessment £4.6bn
Hidden economy £4.1bn
These figures help explain why HMRC does not pursue big business as robustly because its calculations suggest that individuals and smaller businesses are higher risk and responsible for a greater share of tax escaping the Chancellor’s coffers.
This is why Tax Investigation protection is so vital to individuals and businesses. If you have filed your tax returns on time and then receive the dreaded enquiry letter from HMRC, the protection provides peace of mind that you can afford a full defence. However, there are terms and conditions to be aware of, for example tax avoidance or criminal enquiries are not generally covered.
From 1 April 2016 you have to pay a supplement of 3% on purchases of additional residential properties which cost more than £40,000. Where you buy an additional residential property which costs more than £40,000, SDLT is payable at 3% on the first £125,000 of the purchase consideration, at 5% on the next £125,000, at 8% on the next £675,000, at 13% on the next £575,000 and at 15% on anything over £1.5m. The new rates will affect you if you have a portfolio of let properties or if you buy a second home. Speak to your adviser about how the new rates may affect any planned purchase and also the relief available if you sell your previous main residence.
Loss of higher rate relief
Deducting interest from rental income provides relief at the taxpayer’s marginal rate of tax. However, moving to a system of relief in the form of a basic rate tax reduction means that relief is only available at the basic rate. If you are a higher or additional rate taxpayer you will gradually lose tax relief at the higher and additional rates. Speak to your tax adviser about what these changes mean for you.
From April 2017, the government will introduce new allowances for the first £1,000 of trading income and the first £1,000 of property income. Those with income below this level will no longer need to declare or pay income tax on that income. Those with income above the allowance will also benefit by deducting the relevant allowance from their gross income. This appears to be aimed at people starting small businesses on E-Bay and renting on air B&B.
The 20% basic rate band for 2016/17 will be £32,000 and for 2017/18 it was announced that this will be £33,500. This means that you will pay 40% tax if your taxable income exceeds £43,000 for 2016/17 and the threshold will be £45,000 for 2017/18. The 45% top rate continues to apply to taxable income over £150,000 for 2016/17.