We are often asked about the most tax efficient way of extracting funds from Limited Companies for small businesses. There are obviously many variables but a common way of doing it for for owner managers to take a small salary and the rest in dividends.
The main advantage of taking a small salary is to avoid paying National Insurance (both employee and employer’s) on the owner managers salary. Therefore staying at the Secondary Threshold (currently £153 a week or £7956) a year is a good idea as this level does not carry any NI. It also has the benefit of being above the Lower Earnings Limit which means that a year for the basic state pension is accrued. (If there are no other employees then the use of the Employee Allowance, a £2000 Employer’s National Insurance relief, can sometimes make a slightly higher salary worthwhile).
Once this salary has been decided then didvidends can be taken. As Corporation Tax has already been paid on these dividends there can be no additional personal tax to pay. The rates of personal tax on these net dividends (ie the amount of cash you receive) are as follows (on top of a £7956 salary):
Up to £30,518 – no additional tax
Between £30,518 and £82,840 – 22.5%
Over this amount it gets complicated as you lose your personal tax allowance and at £150,000 of total income there is a higher rate tax again.
There are many issues around the numbers above that need individual advice. I haven’t mentioned Child Benefit and losing it if your income is over £50,000 or the minimum wage and how to ensure you are not falling foul of the law. So as you can see it’s complicated! If you are concerned that you are not maximising your taxable income get in touch.
We are often asked to advise on remuneration for a Director of a Limited Company. This is a complex area which can be different for everyone, but one area where clients need to be careful is how they take money out of the Company.
In practice the actual cash that they receive will be a mixture of Salary, Dividends, Expenses and money they have taken out because they need it! In order to keep legal it is important to account for all this money accurately. Some book keeping systems do this very well, for example Freeagent has specific actions for paying out of pocket expenses and dividends.
Whichever method you use for book keeping one of the easiest ways of keeping tabs on your personal money is to use a Directors Loan or Current account. Every time a salary payment or dividend is paid the money will go in to this “pot”. An expense paid personally by a Director will also increase the money in this “pot”.
The director can then take money out iof this “pot”. The problem is when the director takes more money than there is in the “pot” and the account becomes overdrawn. HMRC take a keen interest in this in 2 ways.
If the account is overdrawn 9 months after the year end there will be extra Corporation Tax due (S.455 Tax). This is at a rate of 25% and will be repaid as and when the money is paid back to the Company by the Director. If the overdrawn loan account is paid back between the end of the Company tax year and 9 months after there is no S455 tax due but we need to declare this on the Corporation Tax return. The point of this tax is that otherwise Directors could just take loans from their Company and never pay any income tax!
The other way HMRC take an interest is that if the loan figure goes over £10,000 then a Benefit in Kind will accrue to the Director unless interest is paid to the Company. The benefit in kind is calculated from the average value of the loan and the official interest rate. This would then be entered on the P11d and personal tax would be due from the Director and class 1A national insurance would be due from the Company.
This is a complex area and care needs to be taken. Preferably Directors would not overdraw their loan accounts. Declaration of legal dividends need to be considered and this will be addressed in a future blog post.
A recurring theme from clients is that they don’t want to pay any tax. Unfortunately for most people this is not an option if they have a business is making money. Even Starbucks and Amazon pay some tax, though they tend to choose in which country they pay it, and are big enough to make deals with the countries where they pay the tax to agree a beneficial rate!
So our real challenge is to make sure that clients pay the minimal amount of tax whilst complying with the law. And whilst painful, paying one type of tax can mitigate the need to pay another as the two examples below show. There are many more.
To take an income from a Limited Company an owner Director could pay themselves a PAYE salary like the rest of their staff. This would entail paying Personal Tax and National Insurance on that income. However by leaving the money in the Company, they can then take dividends and pay a lower overall rate of tax. The painful part of this is payin gthe Corporation Tax that is due on the profits of the Company, but by paying this tax the client is enabling themselves to have a lower tax rate overall.
Another example is on incorporation of a sole trade or partnership business. If the goodwill is sold to the Company and the correct elections are made, an upfront payment of Capital Gains Tax at 10% can save Corporation Tax in the future.
So sometimes payment of tax, whilst painful, is necessary. The key is to be paying the correct tax, at the right time.