The End of Corporation Tax “Leakage”

One of the disadvantages of limited companies – and there are many – discussed in Chapter 5 of the Entrepreneur’s Tax Guide is the case of tax “leakage” where a company that is paying marginal rates of CT then pays dividends out to a higher rate tax paying individual.

The problem is/was that the “tax credit” that the shareholder gets when a dividend is paid only gives credit for corporation tax at the 20% rate, so that, if you are an owner manager of a business and pass your income through a company, you will actually pay more than 40% tax overall, as a 40% taxpayer, and more than 45% overall if you are a 45% income tax payer.

It wasn’t that long ago that marginal rates of tax were in the 30% region, meaning that you could massively increase the overall tax burden on your business and personal income, looked at overall, by passing that income through a company.

The book was written during the last knockings of this situation, with the top rate of corporation tax already coming down, but what we now have, promised us any way from next year, is a single corporation tax rate of 20%. So this problem no longer applies, since the tax credit will in all cases match the corporation tax that the company has paid (except, that is, where the company hasn’t paid any!).

This does serve to tip the scales in favour of limited companies quite significantly in some sets of circumstances.

The question might be asked, whether this might provide a replacement strategy for LLP membership, following the Revenue’s attack on “disguised employment” in this year’s Finance Bill. If you can’t pay LLP members without national insurance any more, because they aren’t “really” self-employed under the new regime, why not pay them via dividends from the company itself? Dividends are outside national insurance, so is this a case of problem solved?

Maybe it is in some circumstances, but to me you have to watch very carefully how the issue of shares to the individual staff members is handled. If you issue a set of shares, even if they are non voting, non participating shares, to a group of people, and then immediately start paying substantial dividends on those shares, the Revenue have a potential argument, I would have thought, that these shares are valuable on issue, and the transfer of those shares to the individuals is itself a taxable “perk”. After all, they have got reams and reams of legislation designed to stop the tax efficient transfer of company shares to employees, known as the “Employment Related Securities” legislation.

This doesn’t usually apply to charge tax where the company is a new one, so there could certainly be a lot of mileage in the idea in that situation. If, though, the new trade is simply providing services to an old company, you then have the issue of “IR35” to steer clear of. In some cases you will be able to, in others it may be not so easy.