Sarah Bradford highlights options for extracting company profits in a tax-efficient manner in 2024.
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If you operate your business through a personal or family company, you will need to extract your profits if you want to use them to meet personal expenses outside the company. There are various ways this can be done, some of which are more tax-efficient than others.
As the end of the 2023/24 tax year approaches, it is not sufficient just to consider how to extract profits; it is also necessary to consider when – is it better to take more out before the end of the 2023/24 tax year, or wait until the start of 2024/25?
It should be noted at the outset that there is no ‘one-size-fits-all’ – the optimal strategy is the one that works best for you. It may be that you can pay less tax if you wait until 2024/25 before extracting further profits, but if you have large personal bills to pay early in 2024, that strategy may not work for you. The old maxim of not letting the tax tail wag the dog holds true.
Paying a small salary
A popular and tax-efficient strategy is to take a small salary and to extract further profits as dividends. As long as the salary is at least equal to the lower earnings limit (set at £6,396 for 2023/24 and remaining at that level for 2024/25), the year will be a qualifying year for National Insurance contributions (NICs) purposes. If the salary paid does not exceed the primary threshold (set at £12,570 for both 2023/24 and 2024/25), there will be no primary Class 1 NICs to pay, and the director will be able to secure a qualifying year for zero contribution cost.
Provided the director has their full personal allowance available for the tax year, the optimal salary for 2023/24 and 2024/25 will be £12,570. This is equal to the primary threshold and the standard personal allowance, and at this level the director will not pay any tax or employee’s NICs on their salary.
If the employment allowance is not available (as will be the case if the company is a personal company where the sole employee is also a director), there will be a small amount of employer’s (secondary) Class 1 NICs to pay. For 2023/24 and 2024/25, the secondary threshold is set at £9,100, so on a salary of £12,570, the employer will suffer a NICs bill of £478.86. However, this is a worthwhile price to pay, as the corporation tax savings arising from paying a salary of £12,570 rather than £9,100 and on the employer’s NICs (both of which are deductible for corporation tax purposes) will outweigh the NICs paid by the employer. The rate of corporation tax relief will depend on the company’s profits and will range from 19% to 25%.
If the employment allowance is available (which will usually be the case for a family company with at least two employees), there will be no employer’s NICs to pay, and the salary of £12,570 can be paid free of tax and employer’s and employee’s NICs.
It is not worth paying a salary in excess of £12,570, as the director will need to pay tax at 20% and employee’s NICs (at a composite rate of 11.50% for 2023/24, and at 10% for 2024/25) on the excess over £12,570, which will outweigh any corporation tax savings.
Where the director does not have the standard personal allowance or has used up some of their personal allowance elsewhere, it will be necessary to crunch the numbers to determine the optimal salary. If the director already has the full 35 qualifying years needed for a full state pension, the need to pay a salary to secure a qualifying year is removed.
Extracting profits as dividends
Once a salary at the optimal level has been taken, it is more tax-efficient to extract further profits in the form of dividends rather than to take a higher salary or a bonus. However, there are some traps to avoid.
Dividends can only be paid out of retained profits, and if there are insufficient retained (post-tax) profits in the company to cover the proposed dividend, it will not be possible to pay it. In this situation, it may be necessary to scale back the dividend or, if there are no retained profits, withdraw funds in another way (for example, as a loan or a bonus). It should be noted that salary and bonus payments can be made even if the company is loss making.
A further restriction on the payment of dividends is the need to pay them in proportion to shareholdings. Where the shares of one class are held by more than one shareholder, this limits the ability to tailor dividends to the financial circumstances of the recipient. However, the use of an ‘alphabet’ share structure so that the shares in each class are all held by the same shareholder can remove this limitation, allowing different dividends to be declared for different classes of share so as to tailor the payments to the shareholder’s circumstances.
As far as tax is concerned, all taxpayers, regardless of the rate at which they pay tax, are entitled to a dividend allowance. The dividend allowance is £1,000 for 2023/24 and £500 for 2024/25.
Dividends are taxed as the top slice of income and are tax-free to the extent that they are sheltered by the dividend allowance. However, the dividend allowance uses up part of the tax band in which it falls, so it is really a zero-rate band rather than a true allowance.
To the extent that they are not sheltered by the dividend allowance or the personal allowance (if not used elsewhere), dividends are taxed at 8.75% to the extent that they fall in the basic rate band, at 33.75% to the extent that they fall in the higher rate band, and at 39.35% to the extent that they fall in the additional rate band. These rates apply for both 2023/24 and 2024/25.
Other options
Profits can be extracted in other ways, too.
Employer pension contributions can be tax-efficient if the funds are not needed for personal use outside the company. There is no tax for the director to pay as long as the contributions made do not exceed the director’s available annual allowance, and the company can deduct the contributions when working out their taxable profits for corporation tax purposes, saving them tax too.
It can also be beneficial to take advantage of tax exemptions for benefits-in-kind, such as that for mobile phones, as a way of getting profits out of the company. Zero and low-emission company cars can also be tax-efficient benefits.
If the director needs funds temporarily, taking a loan from the company can also be cost-effective. It is possible to borrow up to £10,000 for up to 21 months without any tax charges arising.
Timing issues
As the tax year end approaches, it is important to review what has been taken out of the company so far in 2023/24. If the director has not used their personal allowance or their dividend allowance, it makes sense to extract profits before 5 April 2024 to use these so they are not wasted. In a family company situation, the availability of family members’ allowances should also be reviewed to see if they can be utilised to extract profits in the 2023/24 tax year.
Remember, the dividend allowance will fall to £500 from 6 April and it may be prudent for shareholders to use 2023/24 dividend allowances before 6 April 2024 (where profits permit) to maximise the opportunity to take dividends free of further tax.
Consideration should also be given to using up the 2023/24 basic rate band if delaying extracting profits until 2024/25 will mean they are taxed at a higher rate.
Where 2023/24 allowances have been used up, it may be preferable to wait until 2024/25 before extracting further profits, if they are not needed outside the company before 5 April 2024.
Practical tip
As the end of the 2023/24 tax year approaches, consideration should be given to when and how company profits are to be extracted, paying a salary or taking dividends before 2023/24 where profits permit and allowances would otherwise be wasted.
