Chris Thorpe looks at company remuneration and highlights some potential pitfalls.
----------------------
This is a sample article from our tax saving newsletter - Try Tax Insider today.
---------------------
When a company has been incorporated, the first thought by the owner is often how one pays oneself. Proper remuneration planning can help mitigate the effects of perceived double taxation of corporation tax for the company and personal tax for the shareholders or directors.
Dividends vs salary
The usual method of extracting profit is to declare a PAYE salary for the directors (who may also have an employment contract to warrant a larger salary and pension – commensurate with their duties), with the shareholders (often also directors) taking dividends.
Whilst the salary is subject to National Insurance contributions (NICs), it is deductible for the company against corporation tax; dividends are subject to lower rates of income tax but are not subject to NICs. However, dividends are not deductible for the company, as they are paid from post-tax profits and distributable reserves.
A fine balance between salary, pensions and dividends can ensure that the combined income and corporation tax burden is minimised.
Other methods of extraction
If a director or shareholder allows their company to occupy land or property, they may charge that company rent, which is subject to income tax, deductible for corporation tax purposes but exempt from NICs.
There are other tax implications of holding property off a company’s balance sheet, such as only 50% business property relief for inheritance tax (IHT) purposes, rather than 100% relief had it belonged to a trading company. Business asset disposal relief for capital gains tax (CGT) purposes is also potentially available for the individual, although the charging of rent may restrict that relief.
These potential issues surrounding IHT and CGT, as well as income tax, for the individual can potentially be resolved by the use of pensions. If the land or property is placed within a pension scheme (usually a self-invested personal pension (SIPP)), the rent paid is generally free of income tax; likewise, any capital growth in the hands of the pension trustees is free from CGT and the value of the property should be outside the individual’s estate for IHT purposes. However, pensions advice is highly regulated, so professional authority for accountants etc. to advise on pensions is restricted and the practicalities may not make it a viable option anyway, although advising on the tax implications is perfectly within a tax adviser’s authority, and it could be a valuable tax-saving option.
Lending money to the company may also produce a further source of income in the form of interest – likewise subject to income tax, but relievable for corporation tax and exempt from NICs. The company will be required to deduct basic rate income tax from the interest at source and complete Form CT61, but it is nonetheless another potential source of income for the individual.
‘Settlements’ anti-avoidance
When spouses or civil partners own a company, one set of well-established anti-avoidance provisions to be mindful of is the settlements legislation. If any form of arrangement or ‘settlement’ essentially diverts income from the creator (the settlor) of the income to their spouse or minor unmarried children, the settlor will be taxed on the income. Lower salaries to the settlor or dividend waivers (which artificially inflate distributable reserves, leading to ‘excess’ dividends subsequently paid to the spouse) are all potential traps under this legislation.
‘Alphabet’ shares and dividend waivers can potentially be red flags to HMRC that gifts of income are being made. However, there is an exemption for spouses if that spouse also owns the capital underlying that income (i.e., the shares). In the House of Lords case Jones v Garnett [2007] UKHL 35 (also known as the ‘Arctic Systems’ case), a wife’s dividends from the fruits of her husband’s work were not subject to the settlements legislation, as she had a genuine half share in the company’s share capital.
Practical tip
Shareholders or directors need to consider remuneration levels and how the salary-dividend balance is to be struck to minimise the tax impact. Spousal co-owners need to ensure that their underlying capital warrants their level of dividends to avoid the potential application of the settlements legislation.
