Beat the 50p tax rate with dividend payments

The 50 per cent tax rate announced by the Chancellor in his latest Budget speech took few by surprise, but has caused consternation amongst those in the higher tax bracket.

The prospect of losing another 10 pence in the pound to the taxman is understandably unpopular among high earners and a large proportion of people are looking for ways to minimise the impact of this increased tax liability.

Luckily, SME (Small and Medium Enterprise) owners are uniquely well placed to do this. Tax planning is a perfectly legal and legitimate activity (as opposed to tax evasion, which is not) – and an activity which can ultimately save you thousands of pounds. As a business owner you can use dividend payments to help mitigate the effects of the new 50 per cent rate.

What are dividend payments?

A dividend is a payment made by a limited company to its shareholders. These payments were initially conceived as a way of divvying up profits among shareholders in the company; a proportion of the profits would be retained for future investment, while the rest would be divided up amongst investors.

Most small business owners are also the major or sole shareholder in their company. This means that you can make dividend payments to yourself – and there are good tax-planning reasons for doing so.

How do dividends lower my tax bill?

Dividend payments are taxed differently to regular income. While regular income is currently taxed at the basic rate of 20 per cent or the higher rate of 40 per cent, dividend payments attract much lower levels of tax. Dividend income up to the basic rate threshold (currently set at £37,400) is taxed at 10 per cent, while dividend income above this threshold is taxed at 32.5 per cent.

You can therefore lower your tax bill by reducing the amount you pay yourself in regular income, and instead taking cash out of your company as dividends.

The payment of dividends is at individual companies’ discretion; you can decide if and when you want to make these payments. As such, dividends can be a very useful tax planning tool – particularly when you are aware of impending changes to the tax schedule.

What should I be careful of?

Unsurprisingly, HM Revenue and Customs are not keen on firms reducing their tax bill. If you are considering using dividend payments in this way you must ensure that you avoid some common but easily overlooked pitfalls.

To begin with, it is vital that the paperwork for all dividend payments is completed properly. You will have to draw up minutes of a board meeting, along with dividend slips, for every payment you make. This can seem ridiculous, particularly if you are the sole director. However, payments made without supporting documentation are unlikely to be accepted by HMRC.

You should also be particularly wary of dividend payments that look like regular income. Many freelancers and contractors choose to pay themselves via monthly or quarterly dividend payments. However, it is again highly likely that these would be rejected by HRMC if the taxman were to look into your affairs more closely – regular payments are likely to be taxed as income, regardless of the means by which they are made. But this should not affect a single dividend payment made with the intention of removing cash before the 50 per cent rate is introduced.

Finally, there are also cash-flow concerns to be considered. Taking a chunk of cash out of your business might be good from a tax planning perspective, but you must make absolutely sure that it will not cause you financial problems later in the year. As such, you should think about drawing up your cash-flow forecasts for the coming year before you make any dividend payments.

Tax planning is perfectly legitimate – indeed, it is an important part of business management. However, HMRC expend a significant amount of energy making life as difficult as possible for those who wish to lower their tax liabilities.You should therefore be especially careful when making dividend payments in order to avoid an even larger bill at a later date, and should always consider seeking advice from an accountant before taking action.