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17th June 2020

Income Tax Planning During Lockdown

Has Coronavirus affected your business? Time to do some lockdown income tax planning…

Man delivering pizza in a face mask - lockdown income tax planning

If you company’s business has been hit by the coronavirus lockdown, chances are it’s the cash flow which has suffered most. But income tax planning during lockdown could be a lifesaver.

In the longer term the downturn is also likely to reduce profits or even result in losses. The lack of cash and profits could allow owner managers to extract profits from earlier tax years efficiently.

Where in previous years your company made profits which you didn’t take as dividends etc., say because you wanted to minimise or avoid higher rate income tax, they will show as reserves on the balance sheet of your firm’s last accounts. You can take them as dividends now, to the extent that any subsequent losses (if any) haven’t reduced them.

Example: ABC Ltd has generated little income in the last seven weeks and since the start of the tax year its director shareholders, Anne and Ben, have taken virtually no income from it as the company has very little cash available. ABC Ltd’s accounts for the year to 31 December 2019 showed reserves of £250,000 while up to date interim accounts show losses for the current year of £5000. Anne and Ben expect ABC Ltd to achieve a modest profit by the end of 2020 but only if they keep their income from ABC Ltd at the current low level. They plan to top up their income from savings. The trouble is this will mean they will barely use their tax-free allowances, let alone their basic rate band of tax. Not a very tax-efficient position.

Anne and Ben could declare dividends out f ABC’s reserves to use their basic rate bands. The maximum rate of tax they would pay on the dividends would be 7.5% making it a vert tax-efficient way to extract some of the £250,000 profit reserves. So while it seems counter intuitive to pay a dividend in year when the company is struggling, it can be tax efficient. 

Before you can access previous profits (reserves) company law requires that you review the subsequent finances to establish that the profits haven’t been eroded or the extent to which they have. Only then can the directors legitimately decide to pay an interim dividend.

If a dividend exceeds a company’s profits it’s said to be ultra vires, i.e. beyond the rights of the directors or shareholders to pay. You might also seen them referred to as illegal or unlawful dividends. Company law means that such excess dividends will usually be treated as loans to the shareholders.

You might think that ABC’s lack of cash poses a significant hurdle if dividends  are to paid from reserves. The good news is it isn’t. The dividends are treated as paid for tax purposes when they are records in the company’s records. Typically for director shareholders this is as a credit to their director’s loan accounts. No cash has to leave the company so the current shortage of cash is no barrier to tax efficient profit extraction. 

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