NCD Query

[sparco]

I'm new here so bear with me, but I guess I'm like a lot of people using this forum - confused by all the legal jargon!

A quick summary...

I formed my own company a couple of years ago, and sought advice on the best way to pay myself, as I was already working part-time. The idea of the company was to provide a second income. Neither the income from the company, nor the income from the part time job is particularly big (both in the region of £8-10k).

At the time, the 10k corporation tax threshold was in place, and myself and my wife were set up as directors. We were both very green at the whole thing, and followed advice which recommended paying ourselves by means of dividends from company profits.

Now we've been completely above board, as far as I am aware, everything declared, everything documented. We completed returns, sent them off, and even received a cheque for a couple of quid that we had allegedly overpaid.

We made profits of roughly £6k in 04/05, under the threshold, filled in the forms to say so and heard nothing more.

We made profits of about £9k for the 05/06 period, £6k before the removal of the £10k threshold, and £3k after Gordon whipped that away, so we sent off our cheque for about £600 and expected to hear nothing more. We actually got a £3 refund

However a demand arrived today for over £1000 for something called 'Non-corporate distributions' for 05/06.

What is this? Is it because we pay ourselves by dividend?

Why didn't we get one for 04/05 when we paid ourselves by dividend in exactly the same way?

If anyone can shed any light on this I'd be most grateful..

[malvolio]

One complete tax year in and HMRC can now assume you will be paying similar amounts in dividends in future. Therefore they bill you for the tax you owe (not unreasonable) and the same again for next year in two 50% chunks payable 6 months apart. You can appeal for a reduction down to any other amount including zero, but if you then wind up owing tax next year you will be charged interest on the difference.

If the income for the next year is likely to be roughly constant, it's worth paying it and getting ahead of the game a little. You're not talking huge amounts, and it will level out over time.

[sparco]

Hmmmm, this isn't sounding good... so much for the £10k threshold! I was genuinely of the opinion that no tax until 10k profit meant just that - no tax until we reached 10k! (and we weren't fiddling to stay under 10k, we genuinely did not reach that mark)

Why would have been advised therefore - by one of the government's own small business advisers (helpful chap on the end of the 'phone when I called asking for advice in setting up a company) - to pay us both via a dividend? Surely I'd have been better advised to pay my wife a small salary instead, thus not incurring this extra tax?

[malvolio]

Not if you have other taxable income streams. You only get one set of allowances. Might be an idea to go talk to an accountant of a properly independent IFA, taxation issues in this area can get complicated!

[ASB]

Hmmmm, this isn't sounding good... so much for the £10k threshold! I was genuinely of the opinion that no tax until 10k profit meant just that - no tax until we reached 10k! (and we weren't fiddling to stay under 10k, we genuinely did not reach that mark)

Why would have been advised therefore - by one of the government's own small business advisers (helpful chap on the end of the 'phone when I called asking for advice in setting up a company) - to pay us both via a dividend? Surely I'd have been better advised to pay my wife a small salary instead, thus not incurring this extra tax?

Ok, I'll try and explain.

For a while the first 10k of profits were taxable at a rate of 0%. This led to a large number of people incorporating, and by careful planning could get 15k tax free (basically 5k salary plus the 10k). The rate between 10k and 50k was increased so that a business making 50k paid exactly the same tax as it did previously.

Fairly quickly the government considered this was abuse and avoidance. What they then did was to introduce a thing called the non corporate distribution rate (NCDR otherwise known as IR591). What this said was, in effect, that any profits that were paid as dividend must have corp tax paid at a minimum aggregate rate of 19%. [Ultimately this means if you made 10k and paid no CT on it, and paid it out as divis then the CT of 1,900 was still due].

What I can't remember is the years it all applied - since it has all been done away with. But searching on HMCR should yield results simply.

Now, for the year you appear to be subjected to the NCDR you would have been better paying Mrs Sparco 5k salary (assuming she had no other income) thus reducing your profits and then paying those as dividends.

As to why you were advised... this may well have been the right advice when you were given it, but YOU have a responsibility to be aware of changes that affect you. Harsh I know, but that's the way it is.

[Bigbird]

When is your company year-end? Your problem hinges on this, and also when the dividends were paid.

I am assuming it isn't the 5th of April as you say this:

£6k before the removal of the £10k threshold, and £3k after Gordon whipped that away

and you paid regular dividends during the year? Therein I think lies your problem. As far as HMRC are concerned they don't care what month you earned your profit in, they are only concerned about what the total amount was at the tax year-end.

The NCD rate was brought in with effect from April 2005 and it simple terms it meant that if you made dividend payments in-year they would be subject to the full (19% at the time) CT rate with no marginal relief. If you left the profit in the company until after the year-end you could claim marginal rate relief on the CT and pay a lesser amount and then pay out the dividends from whatever was left.

I think HMRC are assuming you did the former and that in that case the NCD rate should have been applied to the whole year, not just 3 months of it.