Running a small successful company as a shareholder/director can be challenging and it is important to retain money in the business to help maintain growth. However, the shareholder/director also needs to be able to extract cash from the company to provide a personal income.
There are various ways to extract cash from a company and one current common tax saving opportunity is the low salary with dividend top up scenario. However, post 1 April 2023 when the corporation tax rate increases from 19% to 25% will this still give a favourable result?
Below are various methods for a business owner to extract cash from a company.
Salary payments seem like the most obvious form of extracting cash.
- Salary payments to a director are subject to PAYE (pay as you earn) and employer/employee national insurance.
- There is a tax-fee allowance of £12,570 for the current tax year which means that a salary below £12,570 would not normally be subject to income tax.
- National insurance is payable on earnings above £9,500 per annum.
- The shareholder/director may choose to set the salary at a level to ensure that for national insurance purposes it counts as a year’s ‘stamp’ for national insurance history. This can help to protect future entitlement to state pension and benefits.
As an alternative to a regular salary, a shareholder/director could elect for a one-off bonus.
- Any cash bonus is subject to income tax and national insurance contributions at the same rates as detailed above for Salary.
- If a shareholder/director takes a non-cash bonus then this may be subject to different tax rates.
It is possible as a shareholder of a company, to extract cash in the form of dividends. The shareholder/director should understand the business needs and determine how much annual profit needs to be retained for future business growth and ensure that the decision to pay a dividend is recorded at a board meeting.
- A taxpayer does not have to pay tax on the first £2,000 of dividend income, regardless of the level of non-dividend income. Therefore, the first £2,000 of dividend income is tax-free.
- Dividend income exceeding £2,000 will be taxed at 7.5% for basic rate taxpayers and 32.5% for higher rate taxpayers.
- It is worth noting that dividend income is added to any other taxable income of the taxpayer and may take the taxpayer into a higher tax band.
- Also, dividend payments are not subject to National Insurance contributions.
Contributing to a Pension Plan can be a tax efficient way of extracting money from the company as this is an allowable expense for corporation tax purposes and the individual also gets income tax relief on their contribution.
- The annual allowance for pension contributions is £40,000 for anyone earning up to £200,000 per annum.
- Any pension contribution, in excess, of the £40,000 will be subject to tax.
- Also, the maximum pension contribution must not exceed total income from all sources. So, if personal income is £39,000 and a £40,000 pension contribution is paid, the taxpayer would be liable to pay tax on the £1,000 excess.
- One of the downsides to this is that the money is tied up until the taxpayer reaches at least 55 years of age.
A director’s loan can be a useful low-cost or interest-free source of funds.
- The loan is treated as a form of income and is subject to income tax if the loan is more than £10,000 or if the shareholder/director pays the company interest on the loan below the official rate set by HMRC.
- The shareholder/director should aim to repay the loan to the company either before the end of the company’s financial year or within nine months of the company’s year-end, otherwise the company will be liable to an additional tax charge on the value of the loan outstanding (s455 tax).
From April 2022, the rate of national insurance contributions will increase by 1.25% for employees, employers and self-employed individuals. In addition, there will be an increase of 1.25% to dividend tax rates. These changes combined with the increase in the corporation tax rate from 19% to 25% with effect from 1 April 2023 could impact the tax savings associated with low salary/dividend payments. It therefore may be more tax efficient, going forward, for a business owner to change how they extract cash from their company. If you would like to discuss this in more detail and explore options please contact.
This article outlines only the general principles and tax implications of profit extraction and cannot therefore be applied or relied on in all circumstances. The information is of a general nature and you should ensure you seek specific professional advice appropriate to your own circumstances.