Lee Sharpe looks at profit extraction planning following recent policy announcements.
This article covers the key election manifesto tax pledges by the Conservative Party and how they might affect the typical owner of a family business. This article was written soon after the general election itself, so it is entirely possible that government policy will be further modified over the coming months.
Elephant in the room
Brexit, and whether it was going to go ahead, was a key issue for some parties and voters in the general election. It now looks near-certain that it will proceed broadly ‘as planned’ – whatever that means.
The UK is scheduled to leave the EU VAT regime, Single Market and Customs Union on 31 December 2020. There is provision in the withdrawal agreement to extend membership for up to two further years, to the end of 2022. But the government is adamant that a deal will be reached by the end of 2020, such that the UK will then become a third country for VAT purposes.
The possibility/likelihood of more demanding customs procedures and tariffs on the cross-border movement of goods, etc., is beyond the scope of this article. Businesses that participate in a supply chain that crosses borders will almost certainly benefit from tailored advice.
Triple lock
The government manifesto pledged that there would be no increases in income tax, National Insurance contributions (NICs) or VAT.
Readers may recall a previous similar commitment just before the 2015 general election, swiftly followed by the announcement of a rise in both effective and actual rates of income tax on dividends.
Corporation tax
The government announced in November that the scheduled reduction in corporation tax (CT) from 19% to just 17% from 2020/21 was not going to happen. However, it could have been much worse for companies, given that many political parties wanted to substantively reverse the recent trend of falling CT rates.
For companies able to access the special (and potentially very valuable) relief for research and development expenditure, the Conservatives proposed to increase the main tax credit rate from 12% to 13%. Smaller companies may well prefer the generous small and medium-sized enterprise (SME) regime but it is unclear whether the proposed enhancement under the main scheme will ‘trickle down’ to the SME regime.
There was a proposal also to ‘review’ the scheme, including to see whether investing in cloud computing and ‘data’ should benefit, but a review does not necessarily mean good news for smaller companies, where HMRC is clearly unhappy with a significant proportion of the claims being made.
National Insurance contributions
While promises about triple locks are unlikely to survive the first contact with a bruising Budget, there were specific proposals to:
- Increase the employment allowance from £3,000 to £4,000, which means a significant effective reduction in employers’ NICs costs for many small businesses.
- Increase the threshold at which NICs become payable to £12,500 – sorry, £9,500. The original pledge to align the NICs rate with the income tax personal allowance of £12,500 was later downgraded to an ‘aspiration’ for the mid-2020s, with a more solid commitment to a minimum threshold of £9,500 from April 2020. The threshold for self-employed earners is currently aligned with employees, so presumably any increase in the NICs threshold will likewise apply to both categories.
Assuming that the increased threshold will apply also to employers’ NICs, this is a very expensive measure. The current NICs threshold is £8,632 and it has traditionally risen by around £200-£300 a year. The combined NICs rate for employees and employers is (12% + 13.8%) = 25.8%; increasing the NICs threshold by almost £4,000 in only one or two years will probably bring HMRC out in a rash.
One thing to look out for in the future small print will be an adjustment to abolish the rule which currently provides that anyone earning above the NICs lower earnings limit, (£6,136 in 2019/20), ‘earns’ the right to a state pension even if they don’t actually pay any NICs. While this long-standing provision was originally set up to protect employees with very low earnings, many shareholder-directors of their own companies also orient their remuneration planning around this threshold and the government might well seek to claw back some of the cost of raising the headline NICs threshold by reducing future state pension commitments.
Another measure – far more blatant – would be to increase the upper earnings limit, which marks the cut-off at which primary NICs are charged at just 2% instead of 12% so that higher-earning individuals would pay the higher rate of NICs on more of their incomes. It is possible that if the hike is too extreme, people will complain that it goes against the spirit of the so-called ‘triple lock’.
Capital gains tax
The Conservatives were largely silent on capital gains tax (CGT) but did promise to review and reform entrepreneurs’ relief (ER). ER offers a very substantial reduction in the main rate of CGT, down from 20% to just 10%. However, its perceived cost to the Exchequer has long been a cause for concern at both HMRC and the Treasury. The minimum period for holding qualifying assets was increased from just one year to two years, broadly for disposals on or after 6 April 2019, but that is so recent it is unlikely to have had any tangible effect so far; it would nevertheless be a simple solution to lengthen the minimum qualifying period to something more substantial and, arguably, more in line with a policy to encourage capital growth.
Many small companies are set up to cover single projects – typically in construction or IT – and the shareholder/directors may want to minimise their exposure to high marginal rates of income tax/NICs on salaries and/or dividends. Such companies might then be wound up on the successful completion of the project and the shareholder/directors might well then stand to benefit from ER on any accumulated profits that have not so far been paid out as salary or dividends.
In the right circumstances, ER can offer significant savings, although there are numerous criteria (one has to be both a shareholder and an employee/officer of a company, for example, to hope to get ER on winding it up) and now special anti-avoidance rules, aimed at preventing ‘phoenixing’ companies and re-starting in the same sector. However, a genuine commercial basis for winding up the company should prevent the anti-avoidance legislation from being triggered.
Corporation tax and salaries vs dividends in 2020/21
Keeping CT rates at 19% means that companies are no longer going to become a little more tax-efficient from April 2020.
For example, someone who owns 100% of a company making profits before salary, dividends, and CT of £50,000, and then taking a salary of £8,400 with the balance in dividends, would previously have hoped to take home a little over £700 more in 2020/21 than in 2019/20 because lower CT rates would have meant a larger pool of post-CT profits from which to pay higher dividends.
However, the proposed increase in the NICs threshold will be welcome for many shareholder/directors because they will be able to take more income as salary before triggering an NICs liability, and salary is deductible for CT purposes (while dividends are not).
For example, that same shareholder/director with a company making profits before salary, tax, and dividends of £50,000 will stand to be almost £200 better off if he or she is able to take a little more than £790 a month in salary before triggering NICs.
If that even higher, aspirational limit of £12,500 is reached soon, then the benefit against the current 2019/20 tax year will rise to around £700 – almost cancelling out the money that he or she stands to lose because CT rates are not going down.
Planning tips
- There is little point in trying to defer corporate profits to later than 1 April 2020 to get them taxed at lower rates (although deferring profits is not as straightforward as some people think, in any event).
- Shareholder/directors will probably want in coming tax years to increase their gross salaries to just below the rising threshold at which NICs become payable, to optimise their overall efficiencies.
- The increase in employers allowance will make taking on a spouse, civil partner or close family member for a higher salary more efficient, where they might otherwise waste tax-free personal allowance and lower tax bands – but remember that they must do work to justify the salary being paid!
- Where profits have accumulated in the business and the directors/shareholders hope to benefit from ER, there may well be some cases where triggering a disposal in the current 2019/20 tax year could usefully ‘bank’ ER before it is potentially restricted or even abolished.
In all cases, and particularly against a backdrop of changing legislation, proper tax advice and planning is essential.
