Repay a director’s loan with dividends now or next year?
DIRECTORS’ LOANS!
Repay a director’s loan with dividends now or next year?
You borrowed cash from your company last year and the plan was to clear the debt with a dividend from your company next tax year. The trouble is by then the new higher dividend tax rate will apply. Should you therefore clear the debt sooner?
S.455 charge
If a director shareholder owes their company money which is not repaid within nine months following the end of the company’s accounting period in which the debt arose, it’s liable to a special tax. This is known as a s.455 charge and currently equates to 32.5% of the debt owed after the nine months is up. The charge is a temporary one and HMRC repays the s.455 charge after the end of the accounting period in which the debt is repaid. Tip. The debt can be cleared wholly or partly by the company declaring a dividend which it sets against the amount owed rather than paying it to the director shareholder. This method has advantages over other ways of clearing a debt.
Don’t rush to pay dividends before 6 April 2022 to avoid the tax rate increase from April 2022. Wait until you can accurately estimate your taxable income for 2021/22. Aim to declare an amount that won’t push your overall income into a higher tax bracket than would otherwise apply.
Higher tax rates for dividends
The bad news is that from 6 April 2022 the tax rates which apply to dividends will increase as shown by the table below.
Income tax band
Up to 5 April 2022 From 6 April 2022
Basic dividend rate 7.5% 8.75%
Higher dividend rate 32.5% 33.75%
Additional dividend rate 38.1% 39.35%
Tip. If you’re considering declaring a dividend to clear a debt to your company (or for any other reason), it’s worth considering whether to do so before the new higher rates take effect on 6 April 2023.
Disadvantages to early dividends
Naturally, avoiding the new higher tax rates is sensible, but care needs to be taken to avoid paying a dividend before 6 April 2022 that will push you into a higher tax bracket.
Example. Sarah is the only shareholder and director of Acom Ltd. During its current financial year, which ends on 31 December 2021, Gina borrows £20,000 from Acom. She plans to repay this by declaring a dividend at the end of September 2022. That’s in the 2022/23 tax year when the higher tax rates apply. If she declares the dividend on or before 6 April 2022 the lower tax rates will apply. However, as she expects her taxable income for 2021/22 to be £45,000, adding a dividend of £20,000 will push her into the higher rates so that almost £15,000 will be taxed at 32.5% rather than potentially 8.75% if it was paid on or after 6 April 2022, i.e. in 2022/23. It would seem she might be worse off by declaring the dividend sooner.
Trap. Delaying a dividend until 2022/23 might also push Sarah’s income for that year into the higher rate band for which the 33.75% tax applies. If so she should consider declaring some dividends in 2021/22 and some in 2022/23 to make full use of her basic rate band in both years.
Tip. Leave declaring extra dividends before 6 April 2022 until you can reasonably accurately estimate your taxable income for 2021/22. Try to declare an amount that won’t inflate your taxable income to the point that it pushes you into a higher tax bracket than would otherwise apply.