This week, I continue my consideration of the payment of corporation tax in advance under the system of self-assessment for companies, as is the case under pay and file.
The Inland Revenue expects to ensure that the correct amounts of corporation tax are payable by virtue of a system of interest on underpayments.
The interest will be paid at a commercial rate and will not be tax-deductible.
However, the rate of interest charged will take account of this and, in effect, provide for relief at source at the small companies' rate. Seeing as the system of advanced payment of corporation tax applies only to companies with tax rates above the small companies' rate, this makes the effective interest rate particularly disadvantageous.
In tune with most commercial lenders, the interest payable on overpayments of tax is lower than that charged on underpayments.
A system of penalties will also exist for flagrant and obvious underpayments in order to encourage advance payments of corporation tax to be as close as possible to the correct amount.
So, having understood, broadly speaking, the operation of payments of corporation tax in advance and the largely negative impact this will have on large companies' cash flow – even when measured against the benefit of a reduction in the main rate of corporation tax from 31 per cent to 30 per cent from April 1, 1999 – it is important that small companies are reassured that they will not be affected by these provisions.
On the other hand, they do benefit from the abolition of advance corporation tax to the extent that they are or were likely to have unrelieved advance corporation tax – probably unlikely for most small private companies.
A further benefit concerns cash flow. Where small companies pay dividends to their shareholders – probably so that shareholding directors may avoid National Insurance contributions on money extracted for spending personally – they may do so without having to pay over any funds to the Inland Revenue until nine months after the year end.
This is the date by which corporation tax now has to be paid under the pay and file system.
Add to this the fact that, as is the case at present, there will be no higher-rate tax liability due on the dividend until January 31 following the end of the tax year in which the dividend is received, and the payment of dividends to shareholding directors of private companies looks even more attractive.
Of course, if a salary were paid, not only would the National Insurance be due on it at the employer's and the employee's rate but there would also be the deduction of tax under PAYE at the point of payment.
The point to make here is that there is no corporation tax saving for the company or any tax saving for the individual following the abolition of advance corporation tax. However, there is a cashflow advantage to the dividend paying company and exemption from the payment of corporation tax in advance.
So much for the future. Let us now look at the issues and opportunities that present themselves when IFAs are called upon to advise companies in advance of the year end on how funds should best be extracted to minimise tax and NIC leakage.
In helping to make this decision, it is important to first ascertain the taxpayer's objective in respect of the funds under consideration. For any shareholding director, the first call on funds generated by the company after meeting business expenses incurred in creating profit – assuming there is no other personal income on which to draw – would be securing sufficient personal funds to meet basic personal living expenses.
Next week, I will continue this analysis by examining the dividend or salary decision that will be faced by any company in this position.