What DTC Brand Owners Can Take From Severn Trent's 1.68B Tax Drama

Key Takeaways for Ecommerce Brands:

1. ‍Understand Distributions: Dividends and shareholder draws are powerful tools for managing profits, reducing tax liabilities, and rewarding stakeholders—when used strategically.
2. Profit Shifting Insights: While complex structures like Severn Trent's aren't for everyone, understanding internal profit allocation can help optimize financial outcomes for your business.
3. Tax Efficiency Matters: Whether you're a C corp or S corp, knowing how to structure distributions can lead to significant tax savings and better cash flow management.

An interesting (OK, everything’s relative) topic that has accountants scratching their heads is the latest accounting scandal that just hit the press - this time the (alleged) culprit is Severn Trent Water (Severn), one of England’s top rated water companies. This group services over 8 million people in central England and mid-Wales.

Why should DTC brand owners care?

We'll get to it in a moment, but first, we need a bit of context. As this is a fairly complex accounting issue, I will try to be concise, and speak at a relatively high level.

1. Back in 2017, a shell company named Severn Trent Trimpley (we’ll call it Trimpley) was set up and bought for a minimal £2 by Draycote (who owns Severn), followed by an additional share issuance to Draycote against a £3B receivable.
2. Next, Severn bought 49% of Trimpley (from its parent company, Draycote) for £1.47B, against an additional share issuance to Draycote (probably for accounting purposes, to have less than 50%).
3. To top it all off, following this, it appears that Severn carried out a capital reduction.

Although I am not a UK accountant, and I do not know all of the relevant regulations for public utility companies in the UK (and this very well may be why the cash went through this convoluted structure), these kinds of transactions are fairly common.

Often, they are used to distribute dividends out of one of the companies of a group. In other words, it is pretty much profit shifting between companies that are part of the same group in order to pay out dividends to shareholders.

Now, if you own an e-commerce brand, you may not have (yet) experienced such a complex, convoluted structure.

So you may be wondering why the hell I am even writing this.

However, I think this story serves as a catalyst for complex accounting issues that the general public doesn’t always understand, leading BBC to come out with headlines like "£1.68bn accounts trick inflated water firms books". When in reality, you can actually learn a thing or two from these topics.

So, just a couple of general points that you can take home:

What is a dividend? A dividend is a distribution of a company's profits to its shareholders (either in cash or in additional shares), and they are declared by the company's board of directors. Dividends depend on the company's profitability, retained earnings and cash reserves (some states allow distributions from reevaluation surplus - more on that another time).

What is a capital reduction? This is pretty much a decrease of the company's share capital, by canceling shares or returning excess capital to shareholders.

So, if one company in the group does not have sufficient profits to distribute dividends, it is pretty common to shift profits within the group, in order to allow distribution up to shareholders.

Why would you even think about distributing dividends or shareholder draws, as an ecommerce brand owner?

1. First of all, if you run a C corp, distributions, if qualified, can be subject to lower capital gain tax rates (0, 15 or 20%, plus additional possible surtax) - of course, after paying corporate tax.
2. Second, if you have an S corp, it is not an actual dividend distribution, but rather a shareholder draw, still the concept is similar.

In this case, you generally don’t have additional tax (as the income is taxed on the pass-through individual level), and the drawn amount is not subject to self-employment taxes. You still need to reasonably compensate yourself (more on this in a future blog post; just don’t hold your breath), but this could be very tax-efficient.

So, in short, even if you don’t have the structure (or the tax planning budget) like Severn Trent Water, it is good to have a basic understanding of what distributions look like. It may even reduce your tax bill.

Finaloop's real-time bookkeeping and expert ecommerce accounting team is here to help you improve how you manage your finances. Drop us a line if you want to see how.