Bonus or Dividend? Key issues to be aware of during Covid-19

Peter Rayney uses a case study to look at an owner-manager’s cash extraction plans during Covid-19. 

On a dark December morning, Monty Marshtitch was staring depressingly at ‘his’ company’s management accounts for November 2020.  Monty was the 100% shareholder of Barnsdale Garden Centres Ltd, which operated two garden centres. The business had been ravaged by Covid-19 and whilst almost all the staff has been furloughed for several months, it was still likely to make a trading loss of around £80,000 for the year ended 31 December 2020.  

A dismal year 

He rang up his accountant, Carol Greenwood; “Hi Carol, the figures this year are pretty dismal due to Covid – you will remember that we had to close from March to June this year. I was wondering how much dividend I should take this year? I do not think I can justify ‘my’ usual £150,000”. 

Carol replied – “Yes, most of my clients are grappling with this. As company director, you have a legal fiduciary duty to act in the best interests of the company. Some of my clients have decided not to take anything this year – and have decided to draw down some funds from their director’s loan account instead – just enough to tide them over. They are hoping to be able to repay it by taking a bonus or dividend in late 2021”.   

“That’s not a bad idea” answered Monty. “But – as you know – the company has quite a bit of cash in the bank which we have built up over the years for adverse trading periods like this. I think I would like to take some of this as I still have to live. I was thinking I might be able to take a further £40,000 bonus. How much would the tax be on that? May I take it as a dividend or would a bonus be better? I have already drawn a salary of £50,000 up to the end of November.” 

‘Bonus v dividend’ calculations 

Carol promised to let Monty have some figures so he could make a decision. She prepared a spreadsheet that showed the relevant tax and National Insurance contributions (NICs) costs of paying £40,000 either as a bonus or a dividend. 

Unlike some Covid-19 ravaged companies, the company would not have any Companies Act 2006 obstacles with paying a dividend. While a trading loss is expected for 2020, the company has retained profits of £260,000 brought forward from previous years to cover the anticipated 2020 trading loss and a dividend payment of £40,000. It therefore has sufficient distributable profits to pay a competent dividend.   

The spreadsheet tax calculations assumed that Monty already had £50,000 salary for 2020/21 but no other income. 

Carol emailed the following spreadsheet over to Monty the next morning: 

Monty arranged a Zoom call with Carol: “Thank you for your spreadsheet Carol. Based on your figures, it looks like it is better to pay me a bonus – is that right?  How does the corporation tax repayment arise?” 

Carol reacted: “Yes, as you can see from my spreadsheet (Carol had mastered the Zoom share screen facility!) you can see that there is a small overall saving by paying a bonus – every little helps during these times! We will need to ensure that the bonus is paid by the end of December 2020 to get the corporation tax relief in 2020. Alternatively, we can make a provision in the 2020 accounts with a suitable director’s resolution to crystallise the liability for accounting purposes. The bonus provision must be paid by 30 September 2021 to ensure that we can claim the corporation tax deduction in 2020.” 

“Well I could do with the bonus money soon,” said Monty “So there is no problem there! How do we get the corporation tax refund? Do we need to get the 2020 accounts prepared and tax computation submitted?” 

Corporation tax repayment 

Carol explained: “There is clearly no corporation tax liability for 2020 as there is a trading loss.  However, we can claim the corporation tax back on the total expected 2020 trading loss of £120,000 – which includes your £40,000 ‘bonus’ - by making a loss carry back claim against the company’s 2019 profits. The company has sufficient taxable profits in 2019 to be able to easily absorb the 2020 loss. While it would be good to make an early start on the 2020 accounts and tax computations, we can still get our corporation tax loss refund claim in before we submit the formal 2020 tax computations.”   

“HMRC has announced that they can use special rules to allow companies to obtain their corporation tax loss repayments earlier during Covid-19.  However, they will only allow this provided we can demonstrate that the company has generated sufficient trading losses in 2020 to offset against the taxable profits in 2019 – which is the case here.  Since you maintain reliable management accounts and we can evidence your £40,000 bonus payment, I should be able to send these into HMRC as robust support of our expected trading loss for 2020 and the loss carry back.  This means that we will be able to get the £23,000 or so corporation tax refund in reasonably quickly – which all helps your cash flow position.” 

Monty thanked Carol for her prompt replies. She had cheered him up a little and he reflected how fortunate he was to have such a ‘smart’ accountant and tax adviser in these unprecedented times! 

Practical tip 

Where a company is in distress, extra care must be taken when paying dividends where a company is in distress. The directors have a legal obligation to ensure that the company has sufficient distributable profits to ‘frank’ the proposed dividend payment; and also a fiduciary duty to make sure that the company has sufficient financial resources.