Despite the wide scale speculation that national insurance might be charged on dividends paid by small incorporated businesses, the Chancellor chose in the March 2004 Budget to introduce measures through the corporation tax regime.
The changes preserve the basic principle that corporation tax is charged on the profit for an accounting period, but do affect the rate at which tax is charged on companies whose annual profits are below £50,000.
From 1 April 2004, any company profits which are distributed to individual shareholders will bear corporation tax of at least 19% (the non-corporate distribution rate, NCDR). Lower rates will continue to apply where profits are retained or are distributed to other companies.
The overall corporation tax rate adjustment will depend on the proportion of profits which are distributed. The changes will be most significant for companies with low profits distributing high dividends.
There will be rules to cover situations where distributions made are greater than profits for the relevant accounting period (i.e. from undistributed profits brought forward). These are likely to involve “surplus dividends” being carried forward to future periods to amend the rate of corporation tax when there are undistributed profits arising.
The following examples illustrate some of the basic concepts of the changes:
Example 1
In the year to 31 March 2006, Small Ltd made profits of £12,000 and distributed £10,000 by way of dividend. The tax charge if no profits had been distributed would be £475 (£2,000 @ 23.75%), an “underlying rate” of 3.958% on total profits. Once dividends are taken into account, the charge becomes:
Distributed profit £10,000 @ 19% (NCDR) £1,900
Undistributed profit £ 2,000 @ 3.958% £ 79
Total profit £12,000 £1,979
Therefore the payment of dividends has incurred an additional tax charge of £1,504.
Example 2
In the year to 31 March 2006, A Ltd made profits of £24,000 and paid dividends of £30,000 (drawing on undistributed profits from earlier years). The “normal” tax charge would have been £3,325 (£14,000 @ 23.75%). As the profits are entirely covered by dividends, the corporation tax charge will be £4,560 (£24,000 @ 19%), an increase of £1,235. The “surplus dividend” of £6,000 will be carried forward (see Example 3).
Example 3
In the year ended 31 March 2007, A Ltd made profits of £16,000 and paid dividends of £5,000. Ignoring dividends the tax charge would be £1,425 (£6,000 @ 23.75%), an underlying rate of 8.906%. As there are now undistributed profits for the year, the “surplus dividend” brought forward will be taken into account:
Distributed profit for the year £ 5,000 @ 19% (NCDR) £ 950
Distribution not previously charged £ 6,000 @ 19% (NCDR) £1,140
Balance of undistributed profit £ 5,000 @ 8.906% £ 445
Total profit £16,000 £2,535
Therefore the payment of dividends has incurred an additional tax charge of £1,110.
