When is a dividend taxable?

Director/shareholders can at times find themselves in a situation where they have used business cash to fund personal purchases. It is important to record such transactions adequately in the company books to avoid potential issues with HMRC.

HMRC’s View

HMRC would like to treat all cash drawn for personal use by director/shareholders as salary and thereby account for PAYE tax and NI on the withdrawal. However, there is nothing wrong with this practice and it happens to most owner managed businesses at some point. Despite this, if the transaction is not accounted for adequately you may still encounter problems from potential HMRC questions, especially when Making Tax Digital (MTD) is in full flow.

Record it properly

The chances of HMRC picking this up are small, but they will have a strong case for arguing the payment should have been subject to PAYE tax and NI and will penalise the company accordingly. To ensure the payment isn’t considered as salary, it should be allocated to the director’s loan account (DLA). This can have other tax consequences, but they are far less severe than being hit for PAYE tax and NI and can be managed or mitigated – contact us for more information on this.

Get it right first time

You can’t change your mind with the transaction, e.g. if you use the company’s cash for a personal transaction you can’t later classify the payment itself as a dividend. You can, however, later declare an equivalent dividend, but instead of drawing it in cash you ensure it is balanced against the DLA.

Example Adnan is a director and shareholder of Adnan Ltd. On 1 March 2019 he drew the sum of £1,000 in cash from the company’s bank account to pay for a holiday. The transaction is recorded as a charge to his DLA. He now owes Adnan Ltd £1,000. On 3 June 2019 Adnan Ltd declared an interim dividend but Adnan receives no payment for this. Instead Adnan’s DLA is credited with £1,000 in the books and this wiped out the debt owed.

Dividend timing

In the above example the dividend does not replace the £1,000 as a debit to Hilary’s DLA. It is a separate transaction which, as an interim dividend, is taxable when it’s paid – for tax purposes that’s the date it was credited to Adnan’s DLA. This means it’s not taxable for 2018/19 – when Adnan drew the cash – but in 2019/20 when it was paid.

AJN Accountants are specialists in helping contractors, freelancers and small businesses to save tax and time.

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