In previous years it has been
financially advantageous for business owners and directors to take a small
salary during the year, and take a lump sum dividend at its end. This is
because the rates of dividend tax have been much less than the rates of income
tax. From 6 April 2016, however, this changed and dividend tax has been raised.
The first £5,000 is tax free, at zero
rate. After that the basic rate amount is taxed at 7.5%, but the higher rate
tax amount is 32.5% and for the additional rate it is 38.1%. So there is now
much less advantage in taking high dividends instead of salary.
Government Concerns About Taking Capital on Winding up
Capital gains tax is also much less
than income tax and now is less than both income and dividend tax. The maximum
is 28% but it can be as little as 10% if an individual is eligible for
entrepreneurs’ relief.
It is therefore tempting to take as
much as possible as capital, which you might be able to do on winding up a company.
But the government is wise to this and has set up new rules designed to
discourage it. In certain circumstances they will tax such a distribution as
income tax.
What Are Those Circumstances?
Firstly, the rule will apply if you
are classed as a closed company, ie. one which only has up to five
shareholders, or where the directors have full control of the company.
Secondly, it will apply if a shareholder is paid capital from surplus reserves
following a winding up, but they are involved with a new company set up for the
same purpose within two years. When this is discovered the individual will be
billed for extra tax, probably plus penalties.
The government takes a dim view of
companies dissolved with new ones set up just to avoid higher rates of tax.
They will always charge income tax on capital extracted in such circumstances.
What About Deliberately Retained Profits?
The practice of retaining profits
instead of issuing dividends, so that they can be taken later as capital on
winding up, has also been nipped in the bud. In future it will be penalised so
you need to have a good reason for retaining profits.
Beware any tax adviser who
recommends these dodgy tax avoidance schemes. Your local bookkeepers can assist
you to stay within the law. They will also help you to document any legitimate
reasons for retaining profits and to keep adequate records in case there are
queries from HMRC.
