Can I pay dividends to my children?
Posted on 20th September 2023 at 09:25
Paying dividends to children - avoid the tax traps
Children have their own personal allowance and dividend allowance. At first sight it may seem attractive to pay them dividends to extract profits from a family company in a tax-free fashion; however, there are tax traps that may catch people out.
Dividend income must be declared on the recipient’s Self Assessment tax return, which must be filed online by midnight on 31 January following the end of the tax year (so by midnight on 31 January 2024 for the 2022/23 tax return).
Tax-efficient profit extraction
A popular tax efficient strategy is to take a small salary equal to the personal allowance of £12,570 and to extract further profits as dividends.
All individuals have a dividend allowance, set at £1,000 for 2023/24. To make use of the dividend allowances of family members, a common approach is to make family members shareholders. Using an alphabet share structure where each family member has their own class of share (e.g. A ordinary shares, B ordinary shares, etc.) provides flexibility to tailor dividends to the circumstances of the recipient.
Minor children have their own personal allowance and dividend allowance. Dividends are tax-free to the extent that they are sheltered by the dividend allowance and any unused personal allowance. Consequently, it may seem attractive to make minor children shareholders and to pay them dividends to utilise their personal and dividend allowances to extract profits tax-free.
HMRC's settlement rules
The settlement rules are anti-avoidance rules, one of the effects of which is to treat income from a settlement as that of the parent rather than the child where a parent makes a settlement in favour of the minor child, unless the income is not more than £100 in the tax year.
This means that if a director/shareholder in a family company transfers shares to a minor child of theirs, any dividends paid on those shares would be treated as dividend income of the parent rather than of the child. Consequently, the dividends would be taxed at the parent’s marginal rate of tax, rather than benefitting from the minor child’s personal and dividend allowances.
#tax #dividends #profits
Tagged as: tax planning
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