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CTA s455 Exam Question

CTA s455 Exam Question

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Just for complete clarity this is a CTA exam question, not regarding an actual client!

Just revising for the One Man Band paper and looking at the answer to last November's exam. The first question relates to an outstanding loan to a director-participator, with the usual s455 implications and options for clearing it. The calculations for clearing via a bonus I'm OK with, you have to gross up for tax and NI to make sure that the net left over is enough to clear the loan, but they then do the same for the dividend option which seems wrong to me.

So situation is a loan outstanding of £22,500, the answer suggests declaring a Dividend of £30,000 which will be £22,500 net off 25% Income Tax (£30k grossed up, multiplied by 32.5% higher rate dividend rate, less 10% credit), I agree that based on a £30k dividend the director will end up with £22.5k after tax. What I can't understand is why they are suggesting a £30k dividend at all, surely in the company accounts you see the gross amount of the dividend posted to the DLA and that clears the balance. This dividend will then be taxable in the hands of the director, but surely that shouldn't matter in terms of the companies accounts and tax position, as the dividend is not subject to PAYE it isn't having an amount deducted by the company, it is payable via the directors Self-Assessment. So I'm thinking that the dividend only needs to be £22.5k - i.e. the actual amount of the loan outstanding.

Am I going mad, or missing something fundamental/specific to s455 rules?

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30th Apr 2015 09:40

An assumption

It would appear they are working on the assumption that the director would need to draw the funds to pay the additional tax as well. This is not an unreasonable assumption as, if he had the spare funds, it would be more tax efficient to pay those spare funds into the company and reduce the amount of taxable dividend declared.

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By MattG
30th Apr 2015 09:45

Thanks stepurhan

stepurhan wrote:

It would appear they are working on the assumption that the director would need to draw the funds to pay the additional tax as well. This is not an unreasonable assumption as, if he had the spare funds, it would be more tax efficient to pay those spare funds into the company and reduce the amount of taxable dividend declared.

That's also a good point I hadn't considered. I think I'm too used to dealing with small companies with dividends that are only taxed at basic rate. I still think their model answer could have been more clear mind!

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30th Apr 2015 09:49

I concur

MattG wrote:
That's also a good point I hadn't considered. I think I'm too used to dealing with small companies with dividends that are only taxed at basic rate. I still think their model answer could have been more clear mind!
Model answers should be obviously correct. Stating your assumptions is a key part of good exam practice.
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By MattG
30th Apr 2015 09:54

Plus they explicitly pointed out the additional personal tax cost for the waiver option, but didn't bother for the dividend!

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By MattG
30th Apr 2015 09:43

Never mind I've twigged it, they are suggesting physically paying a dividend, then the director making a physical transfer of the cash back to the company. They are obviously thinking in terms of a discrete one off (or in this case two off) loan, rather than something akin to a directors current account and not jsut crediting a dividend to the DLA, which in practice is how most of these small companies would likely operate. Curse the perfect little world of the exam question!

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By Triggle
30th Apr 2015 10:22

Yes, the problem when a dividend has to be declared that takes a shareholder into higher rate tax is that the one man band shareholder generally only has one source of income - the company itself. So guess how he pays his personal tax.

Does the question also mention payments on account? The shareholder may well be caught either by the 20% rule or the balance of the tax liability being greater than £1k. Guess where the shareholder gets the money to pay the POAs as well.

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30th Apr 2015 10:30

Assume one-off

Triggle wrote:
Does the question also mention payments on account? The shareholder may well be caught either by the 20% rule or the balance of the tax liability being greater than £1k. Guess where the shareholder gets the money to pay the POAs as well.
Assuming this was a one-off, then the payments on account can likely be eliminated on the basis income would be lower in the following year. Again, I'd state such an assumption clearly in an exam.
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By Xi Ng
30th Apr 2015 10:44

One point that hasn't been mentioned

As the salary HAS to be grossed up, the individual's income tax liability has been extinguished (essentially using the company's funds).

In order to compare like with like, it is necessary to assume that the individual will need a dividend sufficient to both clear the loan account and pay the extra tax due as a result of the dividend.

If you don't, you are making an invalid comparison and saying that three oranges are better than two grapefruit.

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30th Apr 2015 11:16

Wonder if you also have to take in to account his personal tax liability on b.i.k on beneficial loan?

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By Xi Ng
30th Apr 2015 11:27

I doubt it

JamesAnd wrote:

Wonder if you also have to take in to account his personal tax liability on b.i.k on beneficial loan?

Does the amount of tax on the loan benefit change depending on whether the loan is cleared by dividend or salary? Or if it is waived, other than in respect of the waiver?

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30th Apr 2015 11:32

What I meant was would any

What I meant was would any tax liability on BIK need to be included when working out what income is needed to clear total liabilities - might be worth additional marks?

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