Tax expert warns of the danger of illegal dividends.

Is there not a way to stop people using a simple piece of tax best practice advice from Simon as a mechanism for selling practice management software?

The clients a firm has are most often a reflection of your firms marketing systems. This include your pricing policy.

Many firms do not have a filtering process in place which lets "bad" clients in. There is often a lack of client development in education and management.

If you employed someone you'd have an induction program because their behaviour is so important. You could have a client induction program.

I was inspired by Paddi Lund and one of the tools we used was a Welcome Book. Type the name in Google and you'll find a wealth of information. Also read the VeraSage and David Maister Web content.

There are enough "good" clients out their. Very often they are bad clients that need a bit of tender loving care and leadership.

Be strong and good luck.

Bob

Surely the crux of this particular element is the assumption the agent knows what the transaction is in the first place. If he or she is just faced with a withdrawal of funds by a shareholder/director with no supporting documentation or other evidence as to what this withdrawal represents, then it is a big leap of faith to identify it as a dividend and difficult to see why HMRC would not have an equally plausible case for arguing for a withdrawal on account of remuneration. That, I assume, is the basis for the warning that (contemporaneous) documentation is a major safety net.
Even if it represents a DLA bookeeping transaction against previous withdrawals, surely it is still prudent to unequivocally establish its true legal nature at that time?

This is another example of the Changing Dynamics of Tax Advice which was the title of a Webinar Gordon Gilchrist and I hosted last month. I focussed on Tax Credit examples provided by Rebecca Bennyworth and Gordon was talking about Tax Schemes. This is another great example of the changes.

It seems to me that for accountants to be effective and protect themselves and their clients they need more time and better information.

In my experience as an accountant in practice clients are unlikely to agree to higher fees. They will probably pouint the finger if things go wrong and under duty of care they probably have a good argument. So, why don't more accountants build service value and help their clients by taking greater interest in the clients books? Is it because most record time and the mentality is time based rather than value based?

Doing this simple act will save you time at the year-end which frees time during the year to advise properly based on good information. The bonus is that all this increases service value and is what clients want so referrals will go through the roof.

Our whitepaper on this can be downloaded from www.moresoftware.biz and I can send a case study of an accountant doing this. In less than 18 months she has won over 100 clients.

This is not a plug for MORE software but to adding value using financial systems in a new way with clients.

Best wishes

Bob

I look after a large number of small Ltd companies, and prepare minutes & dividends paperwork for all of them. I send the paperwork off to the directors to sign and they never do it. I even saw one director who produced the paperwork sent over the previous 2 year (carried arround in a briefcase for safe keeping) and talked and talked about everything - but just would not sign the paperwork...... Others I have to send reminders, and additional copies ..... They seem to have a mental block when it comes this type of paperwork.

I'm going to in future send it with the CT return and accounts, with a "sign here" note. Maybe then they'll sign the paperwork.

Its one thing to produce it - its another to get it signed.

My approach is that if I have a meeting with the clients, maybe on incorporation or maybe at an annual accounts meeting, and I have explained that money drawn may be treated as dividends, that will be taxed to income tax rather than be a corporation tax deduction and I have explained that I will draw up minutes & dividend vouchers to document their decision to draw money that means that it is a dividend. The fact that some of them could not give an explanation of what a "dividend" is because their grasp of anything more technical than a paintbrush or a garden spade is minimal is irrelevant.

Bob

I would like to see that case study and I am interested in such software, I have a few questions and I would prefer you to answer them personally if that's ok?

Email: jasondormer@dormerfinance.co.uk

Thanks.

I'd suggest getting clients to sign one document at your next meeting.

This should be a disclaimer saying that they fully understand the implications. Explian you need this on your permanent file before you can continue to act.

If they don't sign it increase their fee for the additional risk of dealing with them.

Think about it - if there is a problem do you think clients will admit it is their fault or look to blame you?

Good luck and be strong.

Bob

As long as you discuss it with the directors, surely the preparation of the documents is sufficient. After all minutes are nothing more than a *record* of a meeting (over the phone for example), they are not the meeting themselves.

The approach needs to be pragmatic, not bureaucratic. You're only after evidence.

For me all you need is

- accounts
- minutes of a discussion with the directors that passes the articles test for a quorum.
- a payment to the shareholder (or credit to their Loan Account).

Why do you need anything else to prove that a dividend is a dividend?

NeilW

p

Surely the meeting where the resolution proposing the dividend needs to be signed etc?

Software use and signing aside, I want to tackle the comment that HMRC will try to argue excessive dividends should be re-classed as earnings?

I was not aware you could re-class something as something else. I know HMRC may like to do this, but dividends or loans to directors are not the same as salary/earnings, so how does HMRC actually intend to re-class something in this way?

Jason
Holden Associates
The Small Business Blog

Classifying something as something else, refuse the notion of a test case and then fighting you all the way to the House of Lords.

I've just looked at s62 and it's drafted so widely that if it can be said to catch illegal dividends (huge "if" in my opinion), then it would also catch legal dividends. Are the Revenue also looking to reclassify those as well?

I think that everyone of us out there would love it if all our clients were to take this route. However, in practice, a significant proportion of them won't. I have clients which don't care about dividends, they'll take the cash when and where they want to and leave it to us to pick up the pieces and try to make something reasonable out of it.

No amount of lecturing or education is going to change that. Some do change and get on a good system of paying themselves and getting the paperwork up and ready, but some will never. It's all every well to say that these arn't 'good clients' but it all depends on your client base, which many accountants don't have the luxury of picking and choosing.

By this I mean in excess of distributable profits, so illegal in terms of the Companies Act.
The point made is if your paperwork is in order, your dividend is not illegal, it cannot be challenged under s 62, as it is surely the shareholders/directors perogative.

Nichola your article actually said ‘more likely’, not as you now state ‘cannot’.

That aside, I am still not aware how HMRC could ever achieve re-classifying something as something else.

Take your article and add into the mix Andrew Dickers posting, is your article inferring HMRC also try to re-classify loans from the company via a directors loan account as earnings also, after all they will no doubt have no documentation?

Jason
Holden Associates
The Small Business Blog

The article is a summary of some of the points raised by Simon, but the "more likely" or "cannot" is really a question for the courts to ultimately decide.

Jason
You queried the way HMRC reclassify illegal dividends as something else. They do this by relying ITEPA 2003 (I think that it is s7). It is the view of many tax practitioners that ITEPA 2003 was badly drafted and this is what causes us to worry re illegal dividends.

This issue is typical of the environment that is Gordon's legacy in terms of tax law - uncertainty.

How many of you consider tax credits when discussing dividend decisions with clients? If the client is a small close company witht he shares owned by Mr & Mrs who have qualifying childcare costs the potential loss of tax credits from a badly timed dividend can be many times the saving in other taxes. BUT there is the uncertainty as to whether planned dividend timings, (alternate years), will be challenged under the tax credits legislation inherited from social security law on "depriving" oneself of ncome (SI 2002/2006 para 15).

So a chap who has set up a business and then followed Gordon's incentive to incorporate is faced with uncertainty on chalenges from HMRC on:
1 Settlements / Arctic Systems
2 Dividend reclassification
3 Tax Credit "deprived income"

In each case well read conscientous accountants can hold very divergent views, as shown by the disagrreements on this thread.

Back in May 2006 I answered an Any Answers post on the topic of illegal dividends, and mentioned an insolvency case:
Its a Wrap (UK) Ltd (In Liquidation) v (1) Barbara Gula (2) Anthony Gula [2005] EWHC 2015
This case went further to appeal, but its main feature was that illegal dividends were either classed as illegal loans to shareholders, or as repayable dividends. At no time were the dividends ever classed as salary.

It may be a red herring, as no creditor would want to reclassify a payment as salary (unless they were HMRC) but I think it raises further points in favour of the repayable dividend/loan argument. A leopard cannot change its spots and surely what is most important is whether the payment is intended to be a distribution or not.

Most, though I admit not 100%, of my clients do know whether there are profits available, (they know there are profits available because of the accounting systems we set up, though they would not understand the concept of distributable reserves). We, (the clients & I), do make the effort to plan dividends, especially AHEAD of the fiscal y/e. My comments are based on the principles, which should be the same for dividends covered by reserves or dividends which turn out to not be covered by reserves despite planning about the levels of dist res. So I would say that my clients' dividends are properly authorised.

I think that the nub of the issue for dividends, whether or not covered by reserves, is whether the directors honestly thought, (based perhaps on a report from, say, QuickBooks/Sage), that they could validly draw funds and treat them as an income taxable payment rather than a corporation tax deduction.

What I am saying are NOT the issues are:
- whether the directors understood the niceties of tax/company law
- whether they raised minutes at the time