Director’s Dilemma – Year End Personal Tax Strategies

Frequently Asked Business Question:

I am the sole director and shareholder of a trading company with a 31 March financial year-end. With only days to go before the end of the company’s accounting period, what areas should I be looking at from a personal tax perspective?

Top Tip:

Your focus should be centred around the whole area of your remuneration planning, the state of any directors’ loan account that may exist between you and the company, and also potential pension contributions.

Almost all small private company shareholding directors in the UK are remunerated via a combination of a small salary and a larger dividend. This is because dividends declared up to the level of the basic rate tax band are only taxed at 7.5% meaning that a family company controlled by a married couple can extract £100k annually at a very modest personal tax cost.  Furthermore, there is no national insurance charged on dividends which adds further savings for both the directors and the company.  While this is a very favourable tax position, unfortunately, shareholders too often become complacent and do not put the proper procedures and paperwork in place to ensure that these arrangements do not leave the company open to challenge by HMRC during for instance a PAYE inspection. Business owners,  ignorant of tax law or who couldn’t be bothered to pay for proper advice, often simply draw the same amount of money out monthly, post it to ‘wages’ within the company’s accounting system adding the description ‘dividend’.  In footballing parlance, this leaves HMRC with an ‘open net’ to ‘tap in’ a demand for PAYE and national insurance on the grounds that the directors have extracted untaxed wages from the company and not a validly declared dividend.

It is therefore essential therefore that you ensure that any dividends are properly declared and posted to your company accounting system initially and are supported by company board minutes declaring the dividend (having checked that the company has the requisite reserves to declare the dividend) and dividend vouchers should be issued to the recipients to enable them to self-assess themselves to income tax on the dividend within their tax return.  This dividend will create a positive balance on your directors’ loan account (DCA) and thereafter, on usually a monthly basis, the dividend is drawn down and the balance of the DCA reduces. It is important that the DCA balance does not become negative or ‘overdrawn’ as this has both personal and company tax implications.

If the DCA goes overdrawn, the company must pay a special tax (S455) at a rate of 32.5% on the overdrawn balance if the balance is not cleared within 9 months of the year end.  Additionally, the director pays income tax on a notional interest charge applied to the overdrawn balance via the P11d system.  The company also must pay employers NIC on this notional interest amount.

If you have an overdrawn DCA therefore, you have still time to validly declare a dividend and clear your indebtedness to the company.  Remember however, the dividend itself is taxable so you will have to gross it up to cover the tax liability that will result next January.  If the balance overdrawn is large, consider declaring 2 dividends, one on or before 31 March and the second a week later on or after 6 April.  These fall into separate accounting periods and tax years and will prevent the S455 tax applying and also reduce the income tax charge.  Make sure however that the dividends are legally declared and posted to the company’s financial accounting system and if in doubt involve your accountant in the process.