Dividends vs Entrepreneurs Relief

stphnstevey

For a Limited Company, am I right in thinking

(a) Entrepreneurs Relief = 19% Corp Tax already paid on profits, 10% Capital Gains Tax paid . TOTAL 29% Tax

(b) Dividend Tax = 19% 19% Corp Tax already paid on profits. 7.5% basic rate tax on dividends paid up to the higher rate threshold (minus the £2k allowance). TOTAL 26.5%

As Entrepreneurs Relief requires meeting certain criteria and is not guaranteed and it is a similar tax rate to distribute profits as dividends now, I would be better paying up to higher rate tax band NOW, rather than holding money on the company?

TheCyclingProgrammer

If your company is generating sufficient profit each year and also has healthy profit reserves it would certainly be tax efficient to maximise your dividends up to the higher rate tax threshold each year because like you say, you get your personal tax allowance (less any salary you might be taking) + the £2k zero rate dividend band and then the rest at 7.5% tax.

If you are now faced with the option of winding up your company and taking a capital distribution and you also qualify for ER, then assuming profits are greater than the higher rate threshold + the CGT allowance you would probably still be better off taking dividends up to the basic rate band and the rest as a capital distribution. Remember if the retained profits after taking dividends are higher than £25k you will need to formally liquidate the company (an MVL) and this may add a couple of £k in costs.

If your total retained profits are already below the combined higher rate tax threshold + the CGT allowance, the best approach would be:

* Use up any remaining personal income tax allowance + £2k dividend allowance on dividends.
* Subtract the CGT allowance of £12k from whatever profit is remaining and take that as a basic rate dividend.
* This will leave you with retained profits of £12k which means you can wind up the company without a formal MVL and receive the remaining £12k as a capital distribution tax free.

stphnstevey

TheCyclingProgrammer wrote: »

If your company is generating sufficient profit each year and also has healthy profit reserves it would certainly be tax efficient to maximise your dividends up to the higher rate tax threshold each year because like you say, you get your personal tax allowance (less any salary you might be taking) + the £2k zero rate dividend band and then the rest at 7.5% tax.

If you are now faced with the option of winding up your company and taking a capital distribution and you also qualify for ER, then assuming profits are greater than the higher rate threshold + the CGT allowance you would probably still be better off taking dividends up to the basic rate band and the rest as a capital distribution. Remember if the retained profits after taking dividends are higher than £25k you will need to formally liquidate the company (an MVL) and this may add a couple of £k in costs.

If your total retained profits are already below the combined higher rate tax threshold + the CGT allowance, the best approach would be:

* Use up any remaining personal income tax allowance + £2k dividend allowance on dividends.
* Subtract the CGT allowance of £12k from whatever profit is remaining and take that as a basic rate dividend.
* This will leave you with retained profits of £12k which means you can wind up the company without a formal MVL and receive the remaining £12k as a capital distribution tax free.

Thanks for that detailed analysis, its very helpful

I didn't take dividends at the 7.5% level when the new dividend tax rates came in a couple of years ago. Instead I thought when I wanted to retire, to either take ER or continue to draw minimal salary/dividends.

I always thought of the 7.5% dividend tax as 7.5%+CT 19%. So ER looked appealing at 10% CGT. However I only recently realised that CT should be included as it is post tax profits being distributed. So 10%+CT 19%. Looking at it that way, taking dividends now seems appealing, particularly as building too big a reserve in the company might stop me getting ER anyway.

A salary at the personal allowance threshold would attract minimal personal tax and is CT deductible, which is better tax wise than ER or dividends outside the allowance.

Is it actually possible to keep receiving a salary and dividends after you retire? Would this require changing the company into a closed investment company? I could potentially semi-retire and still do some work if needed, to finally drain the company funds.

In retirement, I am wondering whether minimal salary and dividends up to the higher rate threshold, would be better than drawing down my pension? I could still take the 25% tax free amount form my pension and the company salary+dividends. I read that IHT is better for pensions than for a company generally.

TheCyclingProgrammer

particularly as building too big a reserve in the company might stop me getting ER anyway.

I've heard that argument a few times, but I've never really been convinced by it really. HMRC *could* argue the company is being used as an investment vehicle rather than a trading company but IMO as long as you're not actively investing your profits and your company is still actively trading then I don't see why you wouldn't qualify for ER anyway.

Even if you *didn't* qualify for ER, once you've exhausted the basic rate income tax band, CGT is still only 20% (plus the separate CGT allowance) which is preferable to 32.5% or 38.1% dividend rates.

A salary at the personal allowance threshold would attract minimal personal tax and is CT deductible, which is better tax wise than ER or dividends outside the allowance.

IMO, yes it would still be preferable to keep paying yourself a basic salary to reduce your corporation tax bill and also give yourself qualifying years for NI/state pension purposes if that's still important.

Is it actually possible to keep receiving a salary and dividends after you retire? Would this require changing the company into a closed investment company? I could potentially semi-retire and still do some work if needed, to finally drain the company funds.

You could do this - you wouldn't need to worry about ER or CGT as you would just exhaust the company profits by paying dividends. I'm unsure on the salary bit - I guess HMRC could argue that the salary is not an allowable business expense if the business isn't actually trading. The counter-argument being you're still a director with legal responsibilities each year so are entitled to remuneration for that.