Revisions to corporate tax regulations have added complexity to the discussion surrounding the most tax-effective compensation choices for company directors. Emma Clifton, Associate Business Advisory Partner looks at the traditional remuneration strategies when operating through a Limited Company and questions whether this is still the most tax-efficient method.
If you are trading as a Limited Company, you are likely to have previously had a conversation with your tax adviser about withdrawing funds in the most tax-efficient manner. Up until recently, you’ve probably been advised that the best option was to take a low salary with the balance taken as dividends.
If you take a salary up to the National Insurance threshold (currently £9,100) you will not pay any Income Tax or National Insurance, however, this will still count towards your National Insurance years. This means no extra tax payable to HM Revenue and Customs, but you will still be entitled to your full state pension upon retirement.
That all sounds great in principle but £758 per month will barely cover the average cost of a monthly mortgage payment, let alone be enough to support your family. Therefore, unless you have had a recent lottery win (lucky you!) then you will need to top this up and dividends can be an efficient way of doing this.
As a basic rate taxpayer, you will pay tax on your dividends at a rate of 8.75%, compared to 20% on other income. As a higher rate taxpayer, you will pay tax on your dividends at a rate of 33.75%, compared to 40% on other income. This does ignore the dividend allowance currently in place, however with this halving in both 2023/24 and 2024/25, I do wonder if this is being phased out.
For example, if you wanted to take an annual income of £50,000 split as above, your tax liability would be £3,187.62, which is the equivalent of 6.37% of your income. If you wanted to increase this to £100,000, your tax liability would be £19,995.12, which is the equivalent of 20% of your income.
|Dividends Taxed at 0%
|Dividends Taxed at 0%
|Dividends Taxed at 8.75%
|Dividends Taxed at 33.75%
|Tax as a % of Income
As a reminder, it is beneficial to keep your total income below £100,000 to maintain your personal allowance and if you are earning above £50,000 and you are claiming child benefit, you will need to consider disclaiming this.
From a Company perspective, the salary is fully deductible from the profits of the year, which results in a corporation tax saving of £1,729. Dividends are deemed to be a post-tax distribution and, therefore will not attract any corporation tax savings, however given the preferential rates for the shareholder, is it not surprising that no further tax savings are available.
However, having said all of that, the recent changes in the corporation tax rates that came into effect from 1 April 2023 have muddied the waters somewhat. It is now not so obvious that this is the most tax efficient method, and in some cases is no longer the case. The changes in the rates, mentioned below, have reduced the tax savings and means that other factors now need to be considered.
With effect from 1 April 2023, corporation tax rates have increased. If the taxable profits of the Company remain below £50,000, the tax rate of 19% has remained, however this is likely to only be beneficial for a small proportion of businesses. Taxable profits above £250,000 will now attract a corporation tax rate of 25%, which is a 6% increase on the previous rate. Companies with profits in between £50,001 and £250,000 will now suffer a marginal tax rate, equivalent to 26.5%, which is a huge 7.5% increase on previous rates.
Therefore, there are definitely some tax planning opportunities here to reduce the applicable rates, wherever possible. This can include purchasing plant and machinery items, increasing salary levels, as detailed below, or even considering pension contributions, which I have talked about in a previous article.
|Corporation Tax Changes:
|Profits up to £50,000
|Profits between £50,001 and £250,000
|Profits above £250,001
If the Company is subject to 26.5% corporation tax, an increased salary can potentially save tax for the Company, whilst costing the individual 20% tax plus national insurance. If the Company is predicting taxable profits of £55,000, an increased salary could help to bring down the profits to below £50,000, thus attracting the lower corporation tax rate
Is it now more important than ever to work closely with your advisers and to consider the tax rates that will be applicable to the Company and if the current remuneration strategy still holds up in the current regime. The answer may well be yes, but if it’s not, a new strategy could potentially save paying more tax than necessary to HM Revenue and Customs.
As mentioned above, the increased rates and potential reduction in tax savings means that other considerations now come into play. Cash flow and mindset are two of these areas.
If you currently pay yourself a low salary with the balance as dividends, when it comes to your Self-Assessment Tax Return, you will be making a tax payment in January and July each year. Do you always remember to put your tax aside for this? Does it come to January and July, and you have to find the money for the tax payment?
If this is the case, then potentially a higher salary may be an option. The tax is paid on a monthly basis through PAYE and there are no forgotten tax bills at the end of the year. The Company will save the corporation tax at the relevant rates, and you know exactly where you stand.
However, whilst a higher salary would mean that tax is paid on a monthly basis, the dividend route would potentially delay the tax payment until the next tax year. If you took a dividend on 30 April 2024, for example, you would not be required to pay the tax on this dividend until 31 January 2026. This gives you time to plan and save!
As you can see there are a number of factors to be considered and in the current economic climate, it is important to take advice to save any unnecessary tax. Please reach out to Emma if you have any questions or would like to discuss this further by calling 0330 058 6559 or emailing email@example.com