IR591 Update

The media hype and concerns raised over the section in the pre budget speech became something of a damp squib when the measures were announced in the 2004 budget.

Effectively the chancellor has simply removed the advantage of the £10000 zero rate tax band for limited companies that distribute all or the majority of the company's profits to its shareholders.

This will effectively mean that the company will probably( but see below regarding Rev BN 34) pay an extra £1900 per annum in tax (£10000 x 19%) and will still mean that those who have incorporated will be better off tax wise at lower profit levels than if they were sole traders.

It is still not clear what provisions will be made when a company distributes profits earned in a previous year and may therefore have already paid tax on these profits.

Example:

Year 1 Company makes profits after tax of £100,000 but only distributes £60,000 leaving £40000 as retained earnings to be carried forward.

Year 2 Company makes £10000 profit which would normally be taxed at Zero but the company makes a distribution of £20000 to its shareholders.

The mechanics of the measure will be covered in the Finance Bill, but the Inland Revenue have issued a press release ( Rev BN 34 ) giving an idea, although scant, as to how it will work. As the rules will be effective for dividends paid on or after 1 April 2004 , the Bill needs to be published very soon. Those companies that pay weekly or monthly dividends will be affected almost immediately.

The fact that IR35 has not been abolished means that contractors caught by the regime may face double taxation. Once on the deemed salary under IR35 and again when they extract that deemed salary from the company by dividend. The detailed rules may provide some relief against this. It would be nice to know.

A further update will be posted on this website when the exact provisions become known following publication of the Finance Bill.

What is IR591?

On Wednesday 10 December 2003 the Chancellor of the Exchequer announced in his Pre-Budget Report "specific proposals ... to ensure that the right amount of tax is paid by owner managers of small incorporated businesses on the profits extracted from their company".

Section IR591 of the document states:

"The Government has introduced a range of measures and targeted tax reductions to support small businesses; including through reform of capital gains tax, reducing the rate of corporation tax for smaller companies and the introduction of a zero rate, Stakeholder Pensions, and the abolition of advance corporation tax. These measures are encouraging the creation of more small companies, including through self-employed people incorporating their businesses. The Government is keen to ensure the measures it has introduced provide support for these firms taking on the opportunities and responsibilities involved in that transition, and to encourage them to reinvest their profits and grow their businesses. At the same time, the Government is concerned that the longstanding differences in tax treatment between earned income and dividend income should not distort business strategies, or enable reductions by tax planning of individuals' tax liability, and that support should continue to be focused on growth. The Government will therefore bring forward specific proposals for action in Budget 2004, to ensure that the right amount of tax is paid by owner managers of small incorporated businesses on the profits extracted from their company, and so protect the benefits of low tax rates for the majority of small businesses."

The government believes that some companies are taking advantage of provisions which let companies make national insurance and tax savings on dividend payments. When the move goes ahead it is expected that some small owner-managed businesses will pay much higher tax and national insurance.

The proposals have left experts believing that the impact of the IR591 could be far greater than the controversial IR35 tax which has caught thousands of computer contractors and other freelancers. Experts have suggested that as many as 300,000 businesses in the UK could be hit.

More details of the Inland Revenue IR591 legislation are expected early next year.

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