Employers who provided taxable expenses and benefits to employees during the 2020/21 tax year will need to report these to HMRC, on form P11D by 6 July 2021, unless the benefit or expense has been payrolled or is included within a PAYE Settlement Agreement. Benefits covered by an exemption do not need to be included.

Where taxable benefits have been provided, the employer must also file a P11D(b) by 6 July 2021. This is the employer’s declaration that all required P11Ds have been filed and also the statutory Class 1A amount.

Exempt benefit

The tax legislation contains a number of exemptions which remove a charge to tax. These may be specific to a particular benefit, such as those for mobile phones and workplace parking, or may be more general, such as the exemption for paid and reimbursed expenses, which applies if the employee would have been entitled to a tax deduction had they met the expense directly.

There are also a number of temporary Covid-19 specific exemptions that apply for the 2020/21 tax year. These include the provision or reimbursement of Covid-19 antigen tests and reimbursed homeworking equipment (such as a computer) to enable the employee to work at home during the pandemic if the equipment would be exempt if made available by the employer.

Remember, exemptions are only available if the associated conditions are met. However, care must be taken here where provision is made under a salary sacrifice arrangement and the alternative valuation rules apply as this may negate the exemption.

Taxable amount

The amount on which the employee is taxed is usually the cash equivalent value. This is calculated in accordance with the benefit-specific rules where these exists, as is the case for company cars, vans, living accommodation and employment-related loans. Where there is not a benefit-specific rule, the cash equivalent is determined in accordance with the general rule. This is the cost to the employer, less any amount made good by the employee. Amounts made good are only deducted where the employee makes good by 6 July 2021.

If the benefit is provided under an optional remuneration arrangement (OpRA), such as a salary sacrifice arrangement, the alternative valuation rules are used to calculate the taxable amount, unless the benefit is one which is specifically excluded from the ambit of those rules (such as childcare vouchers, pension provision and advice, employer-provided cycles and low-emission cars (l75g/km or less) or within the transitional rules for 2020/21. Under the alternative rules, the taxable amount is the salary foregone or cash alternative offered where this is more than the cash equivalent value.

HMRC produce worksheets which can be used to calculate the taxable amount for some benefits. These can be found on the Gov.uk website.

Reporting options

There are various options for filing P11Ds and P11D(b):

• using a payroll software package;
• using HMRC’s Online End of Year Expenses and Benefits Service;
• using HMRC’s PAYE Online Service; or
• filing paper forms.

Whichever method is used, the forms must be filed by 6 July 2021. Employees must be given a copy of their P11D or details of their taxable benefits by the same date.

Any associated employer-only Class 1A National Insurance must be paid by 22 July 2021 if paid electronically, or by 19 July 2021 if paid by cheque.

To help the hospitality and leisure industry recover from the impact of the first national lockdown, a reduced rate of VAT of 5% was introduced for a limited period from 15 July 2020. The reduced rate of VAT was originally to apply until 12 January 2021. However, in September last year, the Chancellor announced that it would remain at 5% until 30 March 2021.

By the time of the Spring 2021 Budget on 3 March 2021, the hospitality and leisure sectors were suffering the effects of further lockdowns. To provide more help to this sector, the period for which the reduced the temporary 5% rate of VAT will apply has been further extended until 30 September 2021. From 1 October 2021, a new reduced rate of VAT of 12.5% will apply until 31 March 2022. The rate will revert to the standard rate of 20% from 1 April 2022.

Affected supplies

The following supplies will benefit from the reduced rate of 5% until 30 September 2021 and the new reduced rate of 12.5% from 1 October 2021 to 31 March 2022.

1. Food and non-alcoholic beverages sold for on-premises consumption, for example, in restaurants, cafes and pubs.
2. Hot takeaway food and hot takeaway non-alcoholic beverages.
3. Sleeping accommodation in hotels or similar establishments, holiday accommodation, pitch fees for caravans and tents, and associated facilities.
4. Admission to cultural attractions that do not already benefit from the cultural VAT exemption, such as theatres, circuses, fairs, amusement parks, concerts, museums, zoos, cinemas, exhibitions and other similar cultural events and facilities.

Where an admission to an attraction is within the existing cultural VAT exemption, this takes precedence over the reduced rate.

To help meet some of the costs incurred in dealing with the Covid-19 pandemic, the Chancellor announced in his 2021 Budget that a number of allowances and thresholds will remain at their 2021/22 levels until 6 April 2026. Those affected are outlined below.

Personal allowance

The personal allowance was increased to £12,570 for 2021/22, up from £12,500 for 2020/21. It will remain at this level for the following four tax years, up to and including 2025/26.

The personal allowance is reduced by £1 for every £2 by which adjusted net income exceeds £100,000. For these tax years, individuals with adjusted net income in excess of £125,140 will not receive a personal allowance.

Income tax bands

The basic rate band was increased to £37,700 for 2021/22, from £37,500 the previous year. It will remain at this level for tax years up to and including 2025/26.

With a personal allowance of £12,570, the point at which an individual in receipt of the basic personal allowance starts to pay higher rate tax is set at £50,270 until April 2026.

National Insurance threshold

The upper earnings limit for Class 1 National Insurance purposes and the upper profits limit for Class 4 National Insurance purposes are aligned with the point at which higher rate tax is payable. Both are set at £50,270 for 2021/22 and will remain at this level for the following four tax years, up to and including 2025/26.

Other National Insurance thresholds and limits will be reviewed at the appropriate time.

Capital gains tax annual exempt amount

The capital gains tax annual exempt amount remains at its 2020/21 level of £12,300 for 2021/22. It will stay at this level for subsequent tax years up to and including 2025/26.

Inheritance nil rate bands

The inheritance tax nil rate band has been set at £325,000 since 2008/09 and was due for review in 2021. However, it will remain at this level for 2021/22 and subsequent tax years, up to and including 2025/26.

The residence nil rate band (RNRB), which is available where a main residence is left to a direct descendant, remains at its 2020/21 level of £175,000 for 2021/22 and the following four tax years. Where the estate is valued at £2 million or more, the RNRB is reduced by £1 for every £2 by which the value of the estate exceeds £2 million. It is not available where the value of the estate is £2.35 million or above.

Pension lifetime allowance

The pension lifetime allowance limits the amount of tax-relieved pension savings that an individual can build up. The lifetime allowance remains at ££1,073,100 for 2021/22 and for the next four tax years.

Impact of freezing allowances and thresholds

By freezing allowances and thresholds, the tax take will rise and incomes and assets rise with inflation. More people will pay tax and more people will pay tax at higher rates as a result, and more estates will be liable for inheritance tax.

It may be prudent to plan ahead. For example, review the value of the pensions fund before making any further tax-relieved contributions – where the value of the fund exceeds the lifetime allowance, a tax charge is levied on the excess, at 25% where the excess is taken as a pension and at 55% where it is taken as a lump sum.

A popular profit extraction strategy for shareholders in personal and family companies is to pay a small salary and to extract further profits as dividends. The optimal salary will depend on whether the employment allowance is available to shelter any employer’s National Insurance liability that may arise.

Preserving pension entitlement

One of the main advantages of paying a small salary is to ensure that the year remains a qualifying year for state pension and contributory benefit purposes. To qualify for a full state pension on retirement, an individual needs 35 qualifying years.

For the year to be a qualifying year, earnings must be at least equal to the lower earnings limit. A director has an annual earnings limit, and for 2021/22, the annual lower earnings limit is set at £6,240. Where the shareholder is not a director, earnings for each earnings period must be at least equal to the lower earnings limit. For 2021/22, the weekly and monthly thresholds are, respectively, £120 and £520.

Contributions are payable by the employee at a notional zero rate on earnings between the lower earnings limit and the primary thresholds. The employee starts paying contributions once earnings exceed the primary threshold.

Optimal salary – Employment allowance is not available

The employment allowance is not available to companies where the sole employee is also a director. This means that personal companies will generally be unable to claim the allowance.

For 2021/22, the primary threshold is set at £9,558 (£184 per week/£797 per month) and the secondary threshold is set at £8,840 (£170 per week, £737 per month).

Although the maximum salary that can be paid without paying any National Insurance is one equal to the secondary threshold of £8,840 for 2021/22, it is beneficial to pay a higher salary equal to the primary threshold of £9,568. Employer’s National Insurance will be payable on the salary to the extent that it exceeds £8,840 at a cost of £100.46 (13.8% (£9,568 – £8,840)), however, this is outweighed by the corporation tax deduction at 19% on the additional salary and the employer’s NIC.

Once the primary threshold is reached, employee contributions are payable at 12%. At this point, the combined National Insurance cost of 25.8% (13.8% + 12%) is more than the corporation tax saving and paying a salary in excess of the primary threshold is not worthwhile.

Thus, where the employment allowance is not available, the optimal salary is equal to the primary threshold for 2021/22 of £9,568 (£184 per week, £797 per month).

Optimal salary – Employment allowance is available

In a family company scenario, the employment allowance will be available if there is more than one employee on the payroll. As long as the employment allowance is available to shelter the employer’s National Insurance that would otherwise arise, the optimal salary is one equal to the personal allowance, set at £12,570 for 2021/22. No National Insurance is payable until the primary threshold is reached. Above this level, employee National Insurance is payable at the rate of 12%. However, the additional salary saves corporation tax at 19%. However, once the personal allowance has been used, tax at 20% is payable as well as employee’s National Insurance of 12%, which exceed the corporation tax deduction of 19%.

Thus, where the employment allowance is available, the optimal salary for 2021/22 is one equal to the personal allowance of £12,570 (£242 per week, £1,048 per month).

The Self-Employment Income Support Scheme (SEISS) has provided grant support for self-employed individuals whose business has been adversely affected by the Covid-19 pandemic. An extension to the scheme was announced at the time of the 2021 Budget. As a result, it will continue to provide support until September 2021.

Three grants have already been made under the scheme. As a result of the extension, a further two grants will be available. In addition, individuals who started trading in 2019/20 may now be eligible to claim.

Fourth grant

The fourth grant covers the period from February to April 2021 and is based on 80% of three months’ average trading profits. The amount of the grant is capped at £7,500. It is paid out in a single instalment.

To be eligible, the trader must have filed his or her 2019/20 self-assessment tax return and traded in 2020/21. Only traders whose trading profit is not more than £50,000 in 2019/20 or, where trading profit exceeds this level in 2019/20, not more than £50,000 on average over the period from 2016/17 to 2019/20 can benefit from the grant. In addition, income from self-employment must account for at least 50% of the individual’s total income.

To qualify for the grant, the trader must either:

• be trading currently but demand has fallen as a result of the impact of the Covid-19 pandemic; or
• have been trading but is unable to do so temporarily as a result of the Covid-19 pandemic.

The trader must also declare that:

• they intend to continue trading; and
• they reasonably believe that there will be a significant reduction in their trading profits due to reduced business activity, capacity, demand or inability to trade due to Coronavirus.

Claims for the fourth grant can be made online from late April 2021 until 31 May 2021.

Fifth grant

The fifth and final grant will cover the period from May to September 2021. The amount of this grant depends on the extent by turnover has fallen as a result of the Covid-19 pandemic.

Traders who have suffered a reduction in turnover of at least 30% will be eligible for a grant worth 80% of three months’ average trading profits capped at £7,500. A smaller grant worth 30% of three months’ average trading profits capped at £2,850 will be available to traders who turnover has fallen as a result of coronavirus but where the reduction in turnover is less than 30%.

Newly self-employed

When the SEISS was originally launched, only those traders who had filed their 2018/19 tax return by 23 April 2020 could claim. As the filing date for the 2019/20 tax return of 31 January 2021 has now passed, individuals who commenced trading in 2019/20 and who have been adversely affected by the Covid-19 pandemic can claim the fourth and fifth grants under the scheme provided that they had filed their 2019/20 self-assessment return by midnight on 2 March 2021. They will also need to meet the other eligibility conditions.

Grants are taxable

Grants received under the SEIS are taxable and must be taken into account in working out the taxable profits for the year in which the grant is received.

The Chancellor, Rishi Sunak, presented his 2021 Budget on 3 March 2021. The following are some of the key announcements.

Coronavirus Job Retention Scheme to run until September

The Coronavirus Job Retention Scheme is extended until the end of September 2021. The UK government will continue to pay 80% of employees’ usual wages for the hours not worked, up to a cap of £2,500 per month, up to the end of June 2021 For periods in July, CJRS grants will cover 70% of employees’ usual wages for the hours not worked, up to a cap of £2,187.50. In August and September, this will then reduce to 60% of employees’ usual wage up to a cap of £1,875.

Further grants under the Self-Employment Income Support Scheme

The self-employed will also be able to claim two further grants under the Self-Employment Income Support Scheme. The fourth grant will cover February to April 2021 and be worth 80% of three months’ average profits, capped at £7,500. The final grant will cover May to September and will depend on the impact that the pandemic has had on turnover. The final two grants will be available to those who started their self-employment in 2019/20, as long as they filed their 2019/20 tax return by midnight on 2 March 2021.

SSP rebate scheme to continue

The SSP rebate scheme which allows smaller employers to reclaim up to two weeks’ SSP  per employee from the Government for coronavirus-related absences is to continue for the time being. 

Income tax thresholds frozen

For 2021/22, the personal allowance will rise to £12,570. The basic rate band remains at £37,700, meaning that higher rate tax becomes payable for someone in receipt of the standard personal allowance once income exceeds £50,270. Income tax rates are unchanged for 2021/22, at 20%, 40% and 45%, as are the dividend tax rates, which remain at 7.5%, 32.5% and 38.1%.

The personal allowance and higher rate threshold will remain at their 2021/22 level until April 2026.

IHT nil rate band frozen

The inheritance tax nil rate band will remain at its current level of £325,000. The residence nil rate band, available where the main residence is left to a direct descendant, will also remain at its current level of £175,000 until April 2026.

No change to capital gains tax annual exempt amount

The capital gains tax annual exempt amount is unchanged at £12,300 for 2021/22. It will remain at this level to the next five years, up to an including 2025/26.

Pension lifetime allowance unchanged

The pension lifetime allowance, which places a cap on tax relieved pension savings will remain at its current level of £1,073,100 until April 2026. This will impact on individuals with pension savings at or near this level, limiting future tax-relieved pension savings.

Super-deduction for capital expenditure

Companies will be able to benefit from enhanced capital allowances for investment in plant and machinery where the expenditure is incurred between 1 April 2021 and 31 March 2023. A first-year allowance of 130% will be available for expenditure on plant and machinery that qualifies for main rate capital allowances of 18%, while expenditure on plant and machinery qualifying for special rate capital allowances of 6% will qualify for a 50% first-year allowance. This is independent of the Annual Investment Allowance, which can be claimed instead where this is more beneficial.

Carry-back period for losses temporarily increased

Unincorporated business and companies can benefit from a temporary extension in the period for which losses can be carried back. The carry-back period is increased from one year to three years for a limited period. For unincorporated businesses, the extended carry back will apply to losses incurred in 2020/21 and 2021/22. For companies, it will apply to losses incurred in accounting periods ending between 1 April 2020 and 31 March 2021 and 1 April 2021 and 31 March 2022 (subject to a cap of £2m for each accounting period).

Relief is given against profits of a later year before those of an earlier year.

Taking advantage of the measure to carry back losses incurred as a result of the Covid-19 pandemic may generate a much needed tax repayment.

Future rises in corporation tax

The rate of Corporation Tax will increase from April 2023 to 25% on profits over £250,000. A small companies’ rate of 19% will apply to companies with profits or £50,000 or less. Companies with profits of between £50,000 and £250,000 will pay corporation tax at the main rate of 25%, but will benefit from marginal relief. The limits will be reduced to take account of the number of associated companies and for accounting periods of less than 12 months.

Tax exemption for Covid-19 antigen tests

An income tax exemption is to be introduced to apply retrospectively for 2020/21 where an employer reimburses an employee for the cost of a coronavirus antigen test. The exemption will also apply for 2021/22.

The exemptions will also apply for National Insurance purposes.

Temporary SDLT threshold extended

The temporary increase in the Stamp Duty Land Tax (SDLT) residential threshold to £500,000, which was due to come to an end on 31 March 2021, has been extended and will remain in place until 30 June 2021. From 1 July 2021 the threshold will be reduced to £250,000, returning to its usual level of £125,000 from 1 October 2021.

SDLT applies to property purchases in England and Northern Ireland only; Land and Buildings Transaction Tax (LBTT) is payable in Scotland and Land Transaction Tax (LTT) is payable in Wales.

VAT registration threshold remains at £85,000

The VAT registration threshold will remain at its current level of £85,000 for 2021/22 and for the following two years.

Temporary 5% VAT rate for hospitality and leisure extended

The temporary 5% rate of VAT for hospitality, holiday accommodation and leisure attractions will remain in place until 30 September 2021. From 1 October 2021 until 31 March 2022 a new reduced rate of 12.5% will apply, before reverting to the standard rate of 20% from 1 October 2022.

Lockdown restrictions have forced many businesses to close temporarily. Selling goods or clothes on sites such as eBay and Depop offers the opportunity to raise some much needed cash in these difficult times.

What are the associated tax implications and do you need to tell HMRC about it?

Badges of trade

There is a difference between occasionally selling an unwanted item and running an online business. When selling items online, it is necessary to consider whether you are actually trading. The courts have looked to the ‘badges of trade’ to answer this question. These are indicators that taken together provide an overall impression as to whether a trade exists.

The badges of trade are as follows:

• profit-seeking motive — an intention to make a profit indicates trading;
• the number of transactions – systematic and repeated transactions indicate trading;
• the nature of the asset – an asset that it can only be turned to an advantage by sale suggest trading;
• existence of similar trading transactions or interests – transactions that are similar to those of an existing trade may themselves be trading;
• changes to the asset –repairing, modifying or improving the asset to make it more easily saleable or saleable at a greater profit indicates trading;
• the way the sale was carried out – selling the asset in a way typical of trading organisations suggests trading;
• source of finance – selling the asset to repay funds borrowed to purchase it may indicate trading;
• interval of time between purchase and sale – a short interval of time between purchase and sale may indicate trading;
• method of acquisition – assets acquired by inheritance or as a gift are less likely to suggest trading.

There is no single overriding factor that provides conclusive proof that a person is trading; rather it is a question of forming an overall impression by considering the badges of trade.

Trading allowance

Even if the sale of goods amounts to a trade, it’s not always necessary to tell HMRC about it, or pay tax on any profits.

The trading income allowance removes the need to tell HMRC about trading income where the gross annual income from one or more trades is £1,000 or less for the tax year. If you are self-employed and sell goods on eBay as a side line, it is not possible to use the trading allowance for the side line if income from your main trade is more than £1,000 – you must report both to HMRC.

What to tell HMRC

If your gross income from all trades that you carry out is more than £1,000, you must tell HMRC about your income and expenses on your self-assessment tax return (registering for self-assessment first if you are not already registered).

In working out your profit you can either deduct expenses wholly and exclusively incurred in connection with the trade or, if more beneficial, the £1,000 trading allowance. Deducting the allowance will generally be more beneficial if expenses are less than £1,000. However, as the deduction of the allowance cannot create a loss, if after deducting actual expenses there is a loss, it is better to deduct the actual expenses rather than the allowance so you can benefit from the associated loss relief.

If your profits are high enough, you may also need to pay Class 2 and Class 4 National Insurance contributions. For 2020/21, you will need to pay Class 2 National Insurance if you profits from self-employment are more than £6,475 and Class 4 if your profits are more than £9,500.

Under the minimum wage legislation, workers must be paid at least the statutory minimum wage for their age. There are two types of minimum wage – the National Living Wage (NLW) and the National Minimum Wage (NMW). From 1 April 2021, as well as the usual annual increases, the age threshold for the National Living Wage is reduced.

National Living Wage

The NLW is a higher statutory minimum wage payable to workers whose age is above NLW age threshold. Prior to 1 April 2021, it was payable to workers age 25 and above. From 1 April 2021, the NLW age threshold is reduced; from that date it must be paid to workers aged 23 and above.

National Minimum Wage

The NMW is payable to workers who are below the age of entitlement to the NLW. Prior to 1 April 2021, the NMW applied to workers above compulsory school leaving age and under the age of 25; from 1 April 2021, the NMW must be paid to workers under the age of 23 and over the school leaving age.

There are three NMW age bands:

• Workers aged 21 and 22 (prior to 1 April 2021, workers aged 21 to 24).
• Workers aged 18 to 20.
• Workers aged 16 and 17.

Apprentices

There is also a separate NMW rate for apprentices. It is payable to apprentices under the age of 19 and also to those who are over the age of 19 and in the first year of their apprenticeship.

Accommodation offset

Employers who provide their workers with accommodation are able to pay a lower minimum wage to allow for the cost of the accommodation provided. The amount that you are obliged to pay is found by deducting the ‘accommodation offset’ from the appropriate minimum wage for the worker’s age. The daily accommodation offset rate can be deducted for each full day for which accommodation is provided. For these purposes, a day runs from midnight to midnight. The weekly accommodation offset rate is seven times the daily rate.

Rates from 1 April 2021

NLW: Workers aged 23 and above	NMW: Workers aged 21 and 22	NMW: Workers aged 18 to 20	NMW: Workers aged 16 and 17	NMW: Apprentice rate	Accommodation offset
£8.91 per hour	£8.36 per hour	£6.56 per hour	£4.62 per hour	£4.30 per hours	£8.36 per day £58.52 per week

Check you are paying the correct rates

Employers should ensure that the amounts that they pay workers on the NLW or NMW from 1 April 2021 are in line with the new rates. They should also ensure that they have processes in place to identify when a worker moves into a new age bracket. From 1 April 2021, this will include workers aged 23 and 24 who will be entitled to the NLW from that date.

For 2020/21, it was possible to enjoy an electric company car as a tax-free benefit. While this will no longer be the case for 2021/22, electric and low emission cars remain a tax-efficient benefit.

How are electric cars taxed?

Under the company car tax rules, a taxable benefit arises in respect of the private use of that car. The taxable amount (the cash equivalent value) is the ‘appropriate percentage’ of the list price of the car and optional accessories, after deducting any capital contribution made by the employee up to a maximum of £5,000. The amount is proportionately reduced where the car is not available throughout the tax year, and is further reduced to reflect any contributions required for private use.

The appropriate percentage

The appropriate percentage depends on the level of the car’s CO2 emissions. For zero emission cars, regardless of whether the car was first registered on or after 6 April 2020 or before that date, the appropriate percentage for electric cars is 1% for 2021/22. For 2020/21 it was set at 0%.

This means that the tax cost of an electric company car, as illustrated by the following example, remains low in 2021/22.

Example

Jaz has an electric company car with a list price of £30,000. The car was first registered on 1 April 2020.

For 2020/21, the appropriate percentage for an electric car was 0%, meaning that Jaz was able to enjoy the benefit of the private use of the car tax-free.

For 2021/22, the appropriate percentage is 1%. Consequently, the taxable amount is £300 (1% of £30,000).

If Jaz is a higher rate taxpayer, he will only pay tax of £120 on the benefit of his company car. If he is a basic rate taxpayer, he will pay £60 in tax. This is a very good deal.

His employer will also pay Class 1A National Insurance of £41.40 (£300 @ 13.8%).

For 2022/23 the appropriate percentage will increase to 2%.

Low emission cars

If an electric car is not for you, it is still possible to have a tax efficient company car by choosing a low emission model.

The way in which CO2 emissions are measured changed from 6 April 2020. For 2020/21 and 2021/22, the appropriate percentage also depends on the date on which the car was first registered as well as its CO2 emissions. For low emission cars within the 1—50g/km band, there is a further factor to take into account – the car’s electric range (or zero emission mileage). This is the distance that the car can travel on a single charge.

The following table shows the appropriate percentages applying for low emission cars for 2021/22.

Appropriate percentage for 2021/22 for cars with CO2 emissions of 1—50g/km
Electric range	Cars first registered before 6 April 2020	Cars first registered on or after 6 April 2020
More than 130 miles	2%	1%
70—129 miles	5%	4%
40—69 miles	8%	7%
30 – 39 miles	12%	11%
Less than 30 miles	14%	13%

As seen from the table, choosing a car with a good electric range can dramatically reduce the tax charge. Assuming a list price of £30,000, the taxable amount for a car first registered on or after 6 April 2020 with an electric range of at least 130 miles is £300 (£30,000 @ 1%); by contrast, the taxable amount for a car with the same list price first registered before 6 April 2020 with an electric range of less than 30 miles is £4,200 (£30,000 @ 14%).

The moral here is to choose a new greener model and you will be rewarded with a lower tax bill.

Changed business conditions in light of the Coronavirus pandemic have caused many companies to review their dividend policies not least because the company’s financial position may have deteriorated significantly from that shown in its last annual accounts.

The Companies Act 2006 requires that a dividend be paid only if there are sufficient distributable profits. Even if the bank account is in credit the company will need to have sufficient retained profits to cover the dividend at the date of payment. ‘Profit’ in this instance is defined as being ‘accumulated realised profits’.

If a dividend is paid that proves to be more than this amount, is made out of capital or even made when there are losses that exceed the accumulated profits then this is termed ‘ultra vires’ and is, in effect, ‘illegal.’

For private companies there is no need for full accounts to be prepared to prove sufficient profits in the calculation for an interim dividend but they will be needed for the declaration of a final dividend. HMRC’s Corporation Tax Manual states that the accounts need to be detailed enough to enable ‘a reasonable judgement to be made as to the amount of the distributable profits’ as at the payment date.

Therefore, the financial status of the company needs to be considered each time a dividend payment is made which can prove difficult with the payment of interim dividends unless the company is VAT registered and the accountant does the VAT return calculations. The test must be satisfied “immediately before the dividend is declared” and this is generally interpreted to mean that the ‘net assets’ test must be satisfied immediately before the company’s directors decide to pay the dividend. If the directors correctly prepare basic interim accounts and a dividend is paid based on those accounts then that will be deemed lawful, even if, when the final annual accounts, prepared at a later date, show that there was an insufficient amount for distributable profits.

If regular amounts have been withdrawn then the amounts are deemed ‘illegal’ if at the date of each payment the management accounts show a trading loss or the profit cannot support the payment. HMRC will argue that ‘in the majority of such cases’ the director/shareholder of a close company will be aware (or had reasonable grounds to believe) that such a payment as dividend was ‘illegal’.

A significant consequence of paying an ‘illegal’ dividend could arise if the company goes into liquidation when the liquidator or administrator routinely reviews the director’s conduct over the three years before insolvency. If it is found that a dividend has been paid ‘illegally’ then under the Companies Act 2006 rules the shareholders will be expected to repay the amount withdrawn (or the ‘unlawful part’). HMRC will actively pursue this route being as they are often the largest unsecured creditor. Furthermore, under the Insolvency Act a director can be held personally liable for any breach of his or her fiduciary duty to the company.

However, it is not only in liquidation that HMRC could open an enquiry into the treatment of a dividend. HMRC treats a dividend that it perceives to be illegal as being equivalent to a loan and, for a ‘close’ company, this means being a loan to a participator and as such it must be declared on the company tax return. If such a ‘loan’ is not so declared and the financial statements filed online show that the company’s reserves are in deficit at the end of the relevant period then HMRC may raise enquiries. Likewise where the opening balance next year is in deficit but dividends are still paid.

HMRC have also been known to argue that the repayable amount is an interest-free loan and for a director employee could result in a taxable benefit-in-kind should the loan be less than £10,000.