Hey there! I have something really exciting to share with you, a straightforward hack that could make a world of difference in your limited company's tax situation, particularly when you draw dividends. This might not be new to some of you as I've been talking about it for years, yet I find it still quite underutilised.
When setting up your limited company, the typical route is to opt for an off-the-shelf company, but did you know you could tailor it to suit your needs better? Instead, what you want is a company with bespoke articles of association. This not only helps you with tax planning but also provides a legal cushion.
Adjusting your Articles of Association
From a tax perspective, one of the things you can do is amend the articles of association to create different share classes, each with unique rights. This might sound a bit technical, but bear with me. You can adjust the rights on each share class to include different income rights, dividends, capital, and voting rights. Each of these changes can impact your tax implications.
Consider the classic example of a husband and wife tax planning scenario. Perhaps the husband is a higher-rate taxpayer with multiple sources of income, while the wife stays at home, looking after the children and the household. The typical advice given by accountants (not tax advisors) is to grant the wife some shares in the company and pay her dividends, which indeed is tax-efficient.
However, this method doesn't fully utilise the potential tax benefits. With dividends, they must legally be paid in proportion to shareholding. If a £50,000 dividend is drawn from the business and the couple owns the company 50-50, £25,000 would be taxed on him and the other £25,000 on her. This becomes problematic if Mrs. A has all of her basic rate band available because then £25,000 is being taxed at a higher rate when it could be taxed at a lower rate.
Introducing the Alphabet Shares
This is where bespoke articles of association come into play. With different share classes, you can modify the share distribution to capitalise on the tax advantages. These changes can be made at the time of setting up the company or even after the company has been established. It's a relatively straightforward process for professionals and incurs around £500 in fees.
Consider creating "alphabet shares," a strategy that can save you significant amounts in taxes. With this approach, the dividends aren't declared on the class A shares held by Mr. A but instead go to the class B shares held by Mrs. A, taking advantage of her basic rate band and personal allowance.
This strategy allows Mr. A to receive a small dividend amount, using his tax-free amount, while the majority of the dividends go to Mrs. A. By just making this change and having £25,000 taxed at the basic rate (8.75%) rather than the higher rate, you can save over £6,000 per year.
This is not a one-time saving, but something that can be utilised every year for as long as your business exists. The initial cost of setting up your company correctly pays off significantly in the long run.
It's worth mentioning that you can make other changes to the shares, like creating "freezer shares" for future capital rights. However, this is a more complex strategy that requires further consideration.
I hope you found this information useful. This is a simple yet powerful way to transform your company into a more tax-efficient entity. If you enjoyed this article, please give it a thumbs up and don't forget to subscribe for more updates. Your continued support fuels our desire to bring you more valuable content.
Want some related content on accounting and taxes? Visit my YouTube channel: Journey with Marelize