Still on the trail of identifying key issues emanating from this year's Budget and Finance Bill, I would like to turn my attention to the introduction of a minimum rate of corporation tax in respect of profits paid out as distributions (usually in the form of dividends) to other than corporate shareholders, in most cases, individuals and trustees.
Many years ago, there was a principle of apportionment in relation to corporate profits. Before this was abolished in 1989, there was effectively a penalty on undistributed profits. The aim was to make it unattractive to retain profits in a corporate structure where they would bear less tax than had they been distributed.
The latest provision is, in effect, the reverse of this in that it applies a tax penalty to funds distributed – not all distributions, just those made out of a corporate business that is liable to the starting rate of corporation tax (0 per cent on profits up to £10,000) or the first marginal rate (an effective 23.75 per cent on profits between £10,001 and £50,000).
It should be remembered that the latter is an effective rate on profits in excess of £10,000, assuming the first £10,000 is taxed at a zero rate. What actually happens is that the small companies' rate of 19 per cent is applied to the whole of profits up to £50,000, then the tax actually payable is reduced by marginal relief to arrive at the average underlying rate of tax. This underlying rate on all profits will be between 0 per cent on profits up to £10,000 and 19 per cent on profits of £50,000. The nearer actual profits are to £50,000, the nearer to 19 per cent will the underlying rate be.
The problem that the Inland Revenue is seeking to address by imposing the minimum rate is that where dividends are paid out of profits that have borne a rate of less than 19 per cent. Shareholders in receipt of the dividend nevertheless receive a full basic-rate credit.
Of course, even if profits from which the dividend is paid had borne 19 per cent tax, the taxpayer would still receive a credit (22 per cent) that is greater than the tax suffered. However, the Revenue is obviously relaxed about this minor discrepancy. It is clearly less relaxed about what could be a full 19 per cent discrepancy on dividends paid out of profits not exceeding £10,000.
The imposition of the minimum rate is designed to rectify this perceived anomaly.
Ahead of the Budget, there was considerable fear that an NIC charge might be imposed on all dividends so maybe this 19 per cent minimum rate is not so bad. It is, however, evidence of Revenue disquiet over business owners being able to remove funds not subject to NICs and, in the case of companies with profits up to 19 per cent and, consequently, an underlying rate of less than 19 per cent, with insufficient tax deducted at the corporate level.
The minimum rate for dividends paid by these companies was presumably thought to be the easiest way to address the problem. Perhaps it was thought to be too difficult to attempt some kind of recategorisation of dividends as earnings from employment or, in the case of directors, from offices.
Where advisers have corporate clients which will be affected by these provisions, it is important that they are aware of how they will operate. Remember, the provisions are only relevant for companies with profits up to £50,000. For these companies with surplus profits to distribute, the minimum rate needs to be taken into account when determining the relative attraction of taking funds by way of dividend or bonus/salary. The minimum rate only applies in respect of profits distributed to non-corporate shareholders.
How does the minimum rate work? Let us look at two examples – one for a company with profits below £10,000 and one where profits are between £10,000 and £50,000.
Let us assume that profits for an accounting period are £8,000. These are distributed by way of a dividend to individuals. The tax computation would be:
Assume now that profits are £40,000. The distributions made in the accounting period total £35,000, of which £10,000 are made to a company. The tax computation would be:
The new minimum rate will make dividend payments to non-corporate shareholders by affected companies less attractive than before. But the dividend is not subject to primary or secondary NI so it will still be a financially superior method of removing funds from the company than payment by way of salary, regardless of the tax rate of the shareholder/director. The exception is where the recipient is a non-taxpayer and is not made one by virtue of the payment. The payment of salary to such a person would be deductible for the payer and not assessable on the recipient. NICs would also be avoided.