Jennifer Adams considers whether the decision to withdraw monies in the form of salary or dividends has changed for directors of SME’s since the granting of the Employment Allowance as from 6 April 2014.
Background
In a private limited company it is usual for a director also to be a shareholder and as such there is a choice as to whether payments are withdrawn as salary (or bonus) and/or dividend. Which method or combination of methods and how much to withdraw that will produce the minimal amount of tax being paid both by the shareholder/director and the company is dependent upon individual circumstances.
However, for most directors of owner-manager companies the most attractive method to remove funds from a company is via a combination of salary to a set amount, taken with the use of dividends. It is common to see remuneration strategies for such companies placing a heavy bias towards dividends as there is often significant National Insurance Contribution (NIC) savings to be made for both the individual director and company, the reason being that dividends are not liable for NIC payments either by the company or the shareholder. Furthermore, as long as the dividend recipient is not a higher rate tax payer, there is no additional tax payable by the recipient.
Such strategies remain post the Employment Allowance, but what has altered is the proportion of salary (or bonus) v dividend that can be taken to best advantage for both the director and the company.
Pre 6 April 2014, the standard approach was for companies to pay directors a notional salary (or bonus), usually equal to the NIC Lower earnings limit; no tax or NIC was actually due but NIC credits were allowed towards the state pension and some other state benefits. Further funds were then extracted by dividend payment(s). With the introduction of the new ‘Employment Allowance’ for tax years 2014/2015 onwards this standard advice is amended.
What is the employment allowance?
The employment allowance is a reduction of the amount of Employer’s NIC paid up to a £2,000 limit per tax year. It is not a ‘cash-back ' scheme’ rather the claim is for the employer’s NIC payment to be reduced every month until the £2,000 allowance is reached for that tax year.
The government calculate that the employment allowance will enable more than 1.25 million businesses and charities to reduce their NIC liability and of these, it is estimated that around 450,000 employers will no longer pay NIC.
The revised advice
Payment of a salary (and/or any bonus) attracts employee’s NIC’s at the main rate of 12% on earnings above the Primary Earnings Threshold (currently £153 per week) plus an additional 2% on any earnings in excess of the Upper Earnings Limit (currently £805 per week). The employer pays NIC of 13.8% should earnings exceed the Secondary Threshold limit, which is currently the same as the Primary Earnings Threshold, at £153 per week.
Therefore, it will now usually be best advice for a company that has no employees other than directors to allocate a salary of £10,000 per annum (the amount of increased personal allowance for 2014/15) to each director rather than limiting the payment to the NIC Secondary threshold.
Payment of this increased amount will mean that each director will be required to pay an amount of £245 as employees NIC, with the employers NIC charge being £282.07 per director with no tax being paid by the director. The benefit of paying this amount is that the employer’s NIC payments will not be collected, being less than the £2,000 limit. The calculation shows that companies with less than 7 directors will benefit most from this strategy.
Further, the company saves corporation tax as there is a higher gross amount of directors’ salary being tax deductible from company profits which more than makes up for the directors’ employee NIC payment as this calculation shows:
A sole director taking a salary of £10,000 for 2014/2015 will mean additional £2,245 in salary in comparison with the previous year’s payment of £7,755 (the 2013/14 company’s Secondary threshold.) This will save £653.80 in corporation tax (£2,245 x 20%), producing an overall total saving of £408.80 (i.e. £653.80 less employees NIC of £245.00) per director.
Are there any difficulties in claiming the employment allowance?
This strategy is only beneficial where the directors are the only employees and the total employers’ NIC liability is less than the Employment Allowance. The ‘downside’ is the requirement to set up a PAYE payroll scheme and the administration that entails plus the fact that a payment will be required as employees NIC at the end of the tax year.
The payroll system will be required even if the company has one sole director claiming a salary. The claim is made by making a tick in a box on the electronic computerised software which has either been purchased or is HMRC’s own ‘Basic PAYE Tools’ programme.
Is there a change to the amount to pay as a dividend?
Dividends are effectively a ‘reward’ given to shareholders for taking the risk of investing in the company being paid from profits made by the company. Dividends are therefore investment income paid out of a company’s accumulated profits (profit net of expenses including directors salary withdrawn each year) as a return for the shareholders’ investment and as such are not tax deductible.
A dividend can be paid in a loss-making year provided there are sufficient retained profits to do so, but not if a profit has been made but there are retained losses. If no profit has been made or there are no undistributed accumulated profits brought forward from previous years, no dividend can be paid.
The calculation above shows that by using this strategy of a combination of salary/dividends, further amounts can be withdrawn up to the basic rate limit (i.e up to £28,678.50) without paying any additional tax (assuming that there is no other income to be taxed).
Problems may arise if there is more than one shareholder who might or might not be a director as an ordinary dividend must be paid to all shareholders of the company and cannot be paid to just one shareholder in preference to another or be paid at a different rate.
Practical Tip :
For the money saved it is worth applying for a PAYE scheme number and operating a payroll system. The administration can be reduced by the director claiming to be taxed on an annual cumulative basis such that only one submission will be required at the end of the tax year for the amount of £10,000 salary (or bonus) less £245 as employees NIC per director. This amount will be payable by 22 May 2015.
