salary vs dividends

salary vs dividends

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I know that when advising clients on how to structure salary and dividend levels the most efficient way is to get them to pay a salary part way between the first 2 NIC levels such that they get an NIC contribution on their record but don't have to pay any NIC.  I also know that doing this can cause problems if a director wants a mortgage or a pension later on.

Am I the only one out there that fells uncomfortable advising every time that directors structure their pay in this way?  The majority of my company clients are one-man bands often generating in excess of £100k for their companies.  It almost seems like they are asking for trouble from HMRC if they take a salary of between £5 and £6k with the rest as dividends (after CT is withheld of course).  Has anyone experienced HMRC trying to argue that the dividend payments should be in fact re-classified as salary? 

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By andypartridge
14th Jun 2010 10:39

Not a problem (touch wood)

In 15 years I haven't had a single case of HMRC attempting to reclassify dividends as salary. I wonder if it is an urban myth?

I appreciate there can be possible mortgage problems with less enlightened lenders, but as long as you point out the pitfalls along with the benefits your advice is balanced and it is down to the client what they decide to do.

In my experience the vast majority still prefer to go the 'least tax' route.

 -- Kind regards Andy

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By Steve Holloway
14th Jun 2010 11:20

Agreed.

I can add my 10 years to Andy's 15 ... and no accountant I have ever spoken to has a single example of HMRC taking issue with dividends unless incorrectly voted. I have also (well almost) no experience with lenders not understanding how OMB's operate. I am of course assuming that your client base do not have IR35 issues.

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By zarathustra
14th Jun 2010 11:43

WFTC

Are there not issues with tax credit claims if the director is not paid the minimum wage for the hours worked ?

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By cverrier
14th Jun 2010 11:49

..and from the other side

As someone operating as a OMB in that position - my impression is that the standard mortgage web-site applications and call-centres don't have processes to cope when you tell them your salary is £6K with dividends, This means they can't do the proper quick tax calculations to determine your typical monthly income.  You have to persist and speak to 'real' people at head office, and then things usually go OK.

Getting a new mortgage when we moved house (even with the same provider, who advertise themselves as suitable for self-employed/OMB, etc) ) certainly needed a LOT more paperwork sent, but once they had stuff like a couple of years accounts and a confirmation of the dividends from my accountant, it all went through fine.

 

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By User deleted
14th Jun 2010 12:12

Thank you

thank you all for your replies - they are re-assuring.  I was speaking to a trainer the other day who was saying that HMRC are increasingly attacking monthly dividends as actually being salary - he recommended quarterly payments - does anyone have any views on this? 

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By Ken Howard
14th Jun 2010 12:31

Nothing but hot air

You can add my 25+ years as well - never even the faintest whiff from an Inspector wanting to argue dividends are really salary.  Added to that, I've never even experienced them asking for the dividend paperwork, nor even had any arguments about whether the company had adequate distributable profits (even in cases where excess dividends clearly had been made or where they were OK at the time but there were subsequent losses in the same year).  Certainly, never a question about monthly dividends, not even in one case where there was an enquiry and weekly dividends were being paid - the inspector skirted over the dividend issue - may not have even given it more than a few seconds thought!

My opinion is that the CPD trainers are deliberately over-stating the potential risks.  The only people I've ever heard warning about monthly dividends or low salaries are the likes of Mercia CPD lecturers, one of whom actually said that firms "MUST" pay a market salary - needless to say I've not gone to any Mercia courses since if they reel off that kind of drivel!  I've worked in four accountancy practices (all of whom were advising the low salary route as applicable over the years).  No doubt there are some maveric tax inspectors out there who may try it on, but I've certainly not been on the receiving end of any.

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By lfidler
14th Jun 2010 13:20

Rember the Contributions Agency?

I don't even want to think about how many years' experience I have, but I do recall the Contributions Agency arguing that dividends to a single shareholder/manager were effectively earnings for Contributions purposes.  If motive were the sole test, then they were probably right. Since the shareholder concerned had got his paperwork in order to evidence validly declared and paid distributions, we got the problem to go away. As the CA was merged over by the Revenue in 1999, it's not a recent challenge and not one I have seen run since then.  Interim dividends at frequent intervals increase the chances of getting the paperwork wrong or ending up with a distributable reserves problem if the financial year has a disastrous second half, so as usual with tax and NICs, it's worth getting the details right.  I doubt that Mr and Mrs Jones of Arctic Systems fame expected to be a test case when they simply did the same as so many other businesses, so here's hoping your client is not The One.

 

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By clegganator
14th Jun 2010 14:02

No Minimum Wage
WFTC

Are there not issues with tax credit claims if the director is not paid the minimum wage for the hours worked ?

 

Director's aren't subject to minimum wage because they are office holders.

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By Steve Holloway
14th Jun 2010 14:10

"Director's aren't subject to minimum wage because they are offi

Provided they do not have an employment contract ... then they would be subject to NMW.

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By gbuckell
15th Jun 2010 12:40

WTC & NMW

My understanding is that, with no employment contract, directors are not subject to NMW. However, the question concerned WTC. Rebecca did an article in TaxLine a year or so ago saying that the WTC rules had changed and that an individual needed an employment contract in order to qualify for WTC and hence would be subject to NMW. The issue seems to have gone quiet of late. Whether HMRC are taking this point I do not know.

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By User deleted
15th Jun 2010 13:12

WTC

Last time I checked, if you call up to claim WTC and tell them you're earning 6k salary plus dividends they say "Ok, no problem" and process your claim.... D'oh....

But yes, I believe the correct answer is that to claim WTC a director has to be earning NMW.

I also saw an argument that as the combination of salary and divs added up to at least NMW, there wasn't an issue, but I believe this was overrulled by other contributors to the thread in question. Shame.

~Monsoon

(hit the anon box just because I can - and might be the last time! :D)

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By Mallock
16th Jun 2010 11:25

I'm more cautious

Has anyone read the employment related securities legislation? Taken to the letter, anyone receiving dividends which are just disguised income would find themselves paying tax and NI on the dividends.

This is where the market salary argument comes in, because it can be seen that a proper salary is being paid for the work done and any dividends are proper distributions.

I also agree with the argument that dividends should be paid no more regularly that quarterly since that distances the payments from monthly dividends which, when combined with a minimal salary, are nothing more than disguised income.

I wouldn't want one of my clients to be the first test case on the employment related securities legislation.

However what I would really like is the abolition of NI, a compensating rise in Income and Corporation Tax and after that the removal of so much legislation which attempts to prevent what is seen as tax evasion by switching income to those sources not subject to NI. Goodbye IR35!

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By amb.hentons
16th Jun 2010 12:13

Other problems with Dividends

People have mentioned about mortgages and pensions, these can normally be resolved.

The biggest problem I have come across in practice is regarding "income protection policies", death in service policies and the similar. The wording of these policies is salary (and specifically excludes dividends). Therefore, the director could be paying a policy which would only cover a £6K salary rather than £60K of earnings.

Unfortunately, you only need these policies when something happens and it is too late to change the policy.

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By davidirwin1
16th Jun 2010 14:26

Dividends V Salary

I would advocate paying a salary of £10k per annum, with the balance in dividends. That way a director would be receiving more then the minimum wage, whilst mainteining a record of NIC and PAYE income tax. At this salary level the cost of income tax, employees and employers NIC is offest by the benefit in corporation tax say at 21%( for small company profits).

That way the salary cost plus oncost are broadly neutral. The balance can then be withdrawn as dividends with the timing down to the director.

 

Dave Irwin  

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By Malcolm Veall
16th Jun 2010 14:48

£10K salary "broadly neutral"?

Dave,

Having discussed this with so many clients I have to say that they tend not to agree that an extrax tax/NI burden of c.£650pa, (which is the extra burden for a salary of £10K compared to £5.5K), is broadly neutral. 

They take in all the broader arguments but, faced with a few hundred pounds extra to pay over, say, "NI threshold remuneration please".

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By shoshana
17th Jun 2010 15:28

The monthly dividend problem myth

This has been discussed widely on AWEB and recently too.

It is a complete myth that monthly dividends are a problem IF THE PAPERWORK IS DONE PROPERLY.

Of course, many have correctly pointed out that if the client just draws regular amounts out without any evidence of a dividend calculation, then this could be troublesome, but I would be inclined to say this could be a problem with a regular quarterly drawing too.

Even if the company ends up making losses in the second half as people have commented on, this does not make the previous dividends unlawful or voidable if at the time they were declared there were sufficient distributable profits to justify them.

The optimum route, including any impact on S2P is still to take a £5,715 salary and the rest in dividends. Any lecturer suggesting otherwise is doing their audience a disservice, whilst they would be correct to point out any potential problems of doing so (such as increased admin in mortgage applications and loss of earnings insurance).

Having said this, taking a salary equal to the PA limit, currently £6,475 gives a result within about 80p of the optimum, after taking account of the small amount of Class 1 Primary and Secondary Contributions payable and the increased tax relief for the company on the higher salary and Secondary Class 1 NIC. But what is the point in having the PAYE admin if you don't have to.

One advantage the £5,715 salary has for the individual (but one I don't think it should have) is in court-decided divorce settlements - many partners are left with a pitiful maintenance payment based on a salary of £5,715 for the payer, with the dividends being ignored on the basis that they are not guaranteed. Not sure if it is still the case (I am not a lawyer) but was a couple or so years ago as I saw the effects on people I know.

Malcolm Greenbaum

Director - Greenbaum Training and Consultancy Limited

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By honesty
23rd Jun 2010 15:40

Pension payments

Is there any advantage in a client taking pension contributions as salary in addition to the personal allowance. Client has been told this by his tennis partner. Said I would look into it.

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By Dunedin
05th Jul 2010 13:47

PA Holdings case law
 

 

PA Holdings switched from a conventional bonus arrangement to a more involved structure whereby an employee benefit trust was funded by the company, which in turn awarded preference shares to employees. These preference shares duly paid a dividend after which they were redeemed. (There have been some subsequent changes to the tax rules which have rendered unattractive some aspects of this scheme). The company and its employees argued that the dividends should be taxed in the normal way and without any PAYE or NI implications. By contrast, HMRC took the view that the dividends simply amounted to earnings and the normal PAYE/NI deductions should have been made from them. The First Tier tribunal took the view that the dividends were indeed earnings (as well as dividends). See http://www.bailii.org/uk/cases/UKFTT/TC/2009/TC00063.html However, for income tax purposes, the rules state that taxation as dividend income takes precedence over taxation as employment income. Accordingly, the employees were only taxable at the lesser dividend rate and not through PAYE. However, the Tribunal also held that there was no equivalent rule for national Insurance and so both employers and employee National Insurance deductions should have been made. Practical implicationsThe practical implications relate to the boundary between normal dividend payments and those which under the PA Holdings case principles would attract National Insurance contributions as being employment earnings.   For instance, the tribunal said “ “if something is paid out as a distribution by a company to an investing shareholder then the issue of derivation may arise if the shareholder is also an employee. The facts may show that the derivation of a dividend from a share may not be related to earnings because the acquisition and ownership of the share was not related to earnings or more generally to the status of the individual as an employee of the company”. Both HMRC and PA Holdings have appealed the decision. The hearing has taken place and an appeal judgement is expected shortly.      

 

 

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