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Net dividend

Last week, I started to look at the seasonal subject of how best to extract funds from a private company with minimum payment to the authorities. I have already looked at the criteria and formalities for payment, including the payment of interim dividends. This week, I would like to look at the more well-known financial implications.

Dividends are paid out of the net income of the company and are not taken into account in computing its profits for corporation tax purposes. Most important, dividends do not usually give rise to any liability for National Insurance.

Let&#39s start by looking at some fundamentals:

•Advance corporation tax was abolished with effect from April 6, 1999. There are transitional provisions to enable surplus ACT built up before April 6, 1999 to be used subsequently.

•For accounting periods ending on or after July 1, 1999, corporation tax is paid in four quarterly instalments for big companies whose profits are at least £1.5m.

Medium-sized companies (profits between £300,000 and £1.5m) and small companies (profits less than £300,000) will not pay corporation tax in instalments but make a single payment nine months after their year end. Thus, medium-sized and small companies paying dividends are favoured from a cashflow standpoint.

•Since April 1, 1999, the main rate of corporation tax has been 30 per cent. The small companies&#39 rate has been 19 per cent since April 1, 2002. The effective upper marginal rate of corporation tax for 2003/04 is 32.75 per cent.

•From April 1, 2002, a zero rate of corporation tax applies to profits up to £10,000. An effective marginal rate of corporation tax of 23.75 per cent applies to profits between £10,001 and £50,000, at which point the 19 per cent small companies&#39 rate applies to all profits up to £300,000.

Where UK dividends are paid on or after April 6, 1999, the value of the tax credit is set at a fraction of the dividend paid rather than tied to the ACT rate because ACT has been abolished. The tax credit fraction has been fixed at one-ninth of the dividend, which means the value of the tax credit is reduced from 20 per cent under ACT to 10 per cent.

From April 6, 1999, the tax position of the various categories of taxpayer is as follows:

•Non-taxpayer – no tax reclaim available.

•10 per cent taxpayer – no further tax payable as the tax credit will discharge the liability to tax at 10 per cent.

•Basic-rate taxpayer – no further tax payable as the tax credit will discharge the liability to basic-rate tax.

•Higher-rate taxpayer – the higher rate of tax on dividend income has been reduced from 40 to 32.5 per cent to compensate for the reduction of the tax credit to 10 per cent. The net result of this is that a higher-rate taxpayer is in the same position as he was before April 6, 1999.

For example, a dividend of £80 is still worth £60, that is, the grossed-up dividend of £88.89, less tax at 32.5 per cent on £88.89 (£28.89), will be £60.

Understanding of this issue is best secured by studying a series of examples. For example, assuming that a company currently paying corporation tax at the rate of 19 per cent wishes to utilise £10,000 for the benefit of its shareholding director, who is a 40 per cent taxpayer and earning above the employee&#39s upper earnings limit, the above will be the position in respect of dividends for 2003/04.

In my next article, I will go on to compare the position in respect of bonuses for the same tax year.


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