Lee Sharpe looks at the tax-efficient extraction of profits from a family company in the 2023/24 tax year.
Long-term Tax Insider readers will recall that in 2015 the Chancellor of the Exchequer explained it was necessary to ‘reform’ (i.e., increase) dividend taxation, so corporation tax rates could be lowered to 19% and beyond, while balancing the Treasury’s books, thus making the UK internationally competitive.
Since that ‘reform’ was introduced, the so-called dividend ‘allowance’ (that is actually an initial zero rate for dividend income and not an allowance) has been:
- reduced to £2,000 from its original £5,000 in the 2017 Spring Budget;
- reduced to £1,000 from April 2023; and
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will be further reduced to just £500 from April 2024.
The last two adjustments were announced by Chancellor Hunt in his 2022 Autumn Statement.
Ironically, the main rate of corporation tax that the Chancellor was so keen to cut below 20% in 2015 has now shot back up from 19% to 25%, from 1 April 2023.
Meanwhile, the ill-fated Health and Social Care Levy (HSCL), that was set to add at least 1.25% to one’s overall tax bill on earnings, has left its mark. Despite the HSCL itself being formally withdrawn in November 2022, the matched 1.25% hike to dividend taxation mysteriously remains.
Note: I am using the main UK income tax rates; the figures for people in Scotland will differ a little.
Corporation tax rates: A new ‘safe haven’?
The government has carved out a small lower band of profits, theoretically to protect the smallest companies, so corporation tax rates apply from 1 April 2023, as follows:
Profits up to £50,000 p.a. 19.0% (new ‘small profits rate’)
Profits £50,001 - £250,000 p.a. 26.5% (new ‘marginal rate’ – a catch-up band)
Profits £250,001 p.a. and above 25.0% (higher ‘main rate’)
So long as the company’s taxable* profits do not exceed £50,000, the new bands will have no effect. However, the company will effectively pay 26.5% corporation tax on profits above £50,000, for the next £200,000 of annual profits.
The protected band may suffice for many of the smallest limited companies; but dividends are, of course, then paid out of post-tax profits. The new, higher corporation tax rates may therefore take a serious chunk out of the company’s dividend pool, where profits are large enough to be funding the personal income requirements of, say, spouses or civil partners as well, or more than one generation. In other words, not your typical ‘one-man bands’ or ‘singleton companies’, but those with two or four (or more) co-director-shareholders; their annual company pre-tax profits may well be in the £100,000+ range, so they will be paying an unhappy mixture of 19% and 26.5% on company profits, with smaller net reserves as a result, from which they might then pay themselves dividends.
*The strict calculation involves ‘augmented profits’ that include certain classes of dividend income to the company, but, for the vast majority of owner-managed companies, it will resolve simply to taxable profits.
National Insurance contributions
The political panic over the possible effect of the impending HSCL on the average voter forced a quite radical re-think of NICs and, in that context, the March 2022 Spring Statement’s bold decision to significantly increase the primary NICs threshold to £12,570, to align with the income tax personal allowance, was met more with relief than consternation. Was it a panic? Well, I struggle to recall when the government previously changed NICs thresholds in the earnings year itself even once, let alone twice.
While the employment allowance (EA) is aimed at micro-businesses, singleton companies with only one employee (who is the director) are excluded from the EA, so employers’ NICs at 13.8% will arise on any earnings above the employer secondary threshold of £9,100, before the employee primary threshold of £12,570 and without the £5,000 EA ‘credit’ (but it would be quite simple to circumvent that exclusion, as the Chartered Institute of Taxation warned HMRC in its letter of 4 December 2015).
So what is the more efficient level of salary?
Is it better to fix salary at the lower, secondary threshold of £9,100 or to nudge it up to the full £12,570, free of income tax and employees’ NICs but risk paying a little employers’ NICs at 13.8%?
The answer will depend on the level of profits. For a singleton director-shareholder (over 21 but under State Pension age, etc.) with no other income sources and extracting all the company’s profits in salary, topped up with dividends:
As a rule, while it is initially worth pegging salary at £12,570, once the post-corporation tax profits then paid out as dividends take the director-shareholder’s own adjusted income over £100,000 and they start to lose their income tax personal allowance, the saving turns to a cost.
At first, the calculation resolves to a relatively straightforward:
Salary diff. x (corporation tax rate x (1+employers’ NIC rate) – e ’ers’ NIC rate) x (1-effective marginal income tax rate)
e.g., at the small corporation tax and basic income tax rates (profit of, say, £30,000 before salaries):
(£12,570-£9,100) x (19% x (100%+13.8%) - 13.8%) x (100%-8.75%) = £248 (as per the above Table)
The ‘effective marginal income tax rate’ will start off being the marginal dividend income tax rate, but not after the personal allowance starts to be eroded. For example, where the company’s annual profits are £275,000, the calculation is:
Salary diff. x (1-effective marginal income tax rate) - salary diff. x (1+e’ers’ NIC rate) x (1-CT rate) x (1-div rate)
(£12,570-£9,100) x (100%-(20%+(39.35%-8.75%))) - (£12,570-£9,100) x (100%+13.8%) x (100%-25%) x (100%-39.35%) = (82)
The above calculations assume the singleton director-shareholder cannot use employment allowance, so employers’ NICs will be due on any salary paid above £9,100 in 2023/24. Where the employment allowance is available, it will ‘knock out’ up to £5,000 of employer NICs, favouring the higher salary.
Conclusion: Optimising the mixture and the timing to mitigate ever-more expensive tax policies
Companies and their UK-resident shareholders are paying a lot more tax than they used to, and it is getting progressively worse. Chancellor Osborne ‘reformed’ dividend taxation back in 2015, starting in April 2016. Under normal self-assessment tax return and payment rules, it took until 31 January 2018 before shareholders felt the consequences in their balancing payments for 2016/17 – roughly 2½ years later. The recent 1.25% increase in dividend rates took effect from 6 April 2022, so it will typically be January 2024, when balancing payments for 2022/23 may bite a little more deeply than in the last few years.
But the real pain is likely if and when the post-corporation tax profits that fund shareholder dividends are so high, they have already been taxed at 25% or 26.5%, not just 19%. This may be for dividends being paid now, in 2023/24, but they could be paid in (say) April 2024 or later, in early 2024/25 – so deferring the personal tax reckoning to 31 January 2026. But there can, of course, be tax consequences to taking ‘too much’ out of the company for private purposes or paying dividends to replenish director-shareholder loan accounts ‘too late’.
For many family companies, there is some careful planning to do between now and then, balancing the needs for private funds, company loans to directors and the timing of salary and dividends. This evaluation may be more complex and more finely balanced than ever, particularly where individuals have significant incomes from outside the company or the company is highly profitable.
