The Autumn Budget did not involve any surprise announcements affecting shareholder directors. Nevertheless, this may be a good time to consider some planning options as we discuss below.
Leaving funds in the business
For those business owners who have sufficient ‘spendable’ income, the most effective way to limit their overall tax bill is to choose to leave profits in the company rather than draw either a dividend or salary. With the top rate of income tax currently at 45%, there is an obvious argument for allowing profits to stay within the company, where the maximum tax rate (for the Financial Years beginning 1 April 2017 and 2018) will be 19% and is scheduled to reduce to 17% in 2020.
The government is aware that the disparity in the rates of corporation tax and income tax gives rise to opportunities for tax reduction and it is material. This is particularly the case where the director leaves profits in the company, pays a low rate of corporation tax on those profits with the resulting cash then forming an asset of the company. That cash can potentially then be accessed by the shareholder then liquidating the company and only paying CGT at 10% provided entrepreneurs’ relief is available. This strategy has tax risks in terms of future changes to the eligibility for CGT entrepreneurs’ relief and inheritance tax business property relief. Also, where a company is liquidated by a shareholder and that shareholder starts up a similar business within 2 years of liquidation (a “phoenix company”), the capital arising on the earlier liquidation can be recategorised as a dividend for tax purposes.
Money left in the company is also money exposed to the claims of creditors, so professional advice should be sought before turning a business into a money box. Furthermore, to combat this practice, the government is looking at ways in which they can prevent this practice by imposing higher tax charges in such circumstances.
It is worth noting that excess cash can result in the loss of IHT business relief if the cash is treated as an excepted asset because it has no business purpose.
Payments to a director/shareholder in 2017/18
For those who need to draw funds out of the company, the next issue that will arise is what is the most tax efficient way to withdraw profits – assuming, of course, that the director needs to withdraw the cash.
One planning point that a number of companies operate is short-term loans to director/shareholders. In this respect, the government has made short-term loans from a company to a shareholder less tax attractive by imposing a 32.5% tax charge if those loans are not repaid within 9 months of the end of the accounting period in which the loan is made. This tax can be reclaimed if and when the loan is repaid.
The more conventional method of drawing profits out of a business is by remuneration or dividends. The dynamics on whether a director/shareholder should draw remuneration from a company by way of remuneration or dividends has changed over the last couple of years because of the taxation changes on dividends.
To recap, since 2016/17 the tax charge on a dividend for a basic rate taxpayer is 7.5%, 32.5% for a higher rate taxpayer and 38.1% for a 45% taxpayer.
However, all taxpayers will be entitled to a £5,000 dividend allowance (effectively a £5,000 nil rate band). This is due to reduce to £2,000 in 2018/19 and so the position will then change again.
Currently, for a higher rate shareholder/director taxpayer who has their full dividend allowance available, drawing dividends will still be more financially attractive than bonuses.
For those who are looking at remuneration strategies in the run up to the end of the 2017/18 tax year, the best strategy to adopt will obviously depend on all the tax circumstances of the individual or company. But despite the increased tax rate on dividends in excess of the allowance, dividend payments will mostly remain the more attractive option due to the NIC saving. Of course, with the reduction in the dividend allowance to £2,000 in 2018/19, the position will need to be reviewed for that tax year.
For example, let’s take the case of Bill who is the controlling shareholder of a private company which has £25,000 of gross profits which he wishes to draw, either as bonus or dividend in 2017/18. Assuming the company pays corporation tax at the rate of 19% and Bill is already a higher/additional rate taxpayer with annual income in excess of £45,000, the choice in 2017/18 can be summarised as follows:
|Amount available (gross profit)
|Corporation tax @ 19%
|Employer’s National Insurance Contributions £21,968 @ 13.8%
|Director’s NICs £21,968@ 2%
|Income tax *
|Net benefit to director
* Amount available as a bonus to director is net of employer’s national insurance contributions
** Assumes full £5,000 dividend allowance is available
Of course, in 2018/19, the dividend allowance will reduce to £2,000 and this means that the net benefit to a director taking a dividend will reduce to £14,319 (40% taxpayer) and £13,297 (45% taxpayer). Therefore the dividend route will still remain preferable but with the net benefit having been somewhat reduced.
Employing the spouse
The Employment Allowance (EA) which increased to £3,000 with effect from 6 April 2016, is not available for employers with only one employee – typically the director/shareholder. In such cases it may therefore be worth the company employing the spouse. For 2017/18 it will make little sense for the spouse to be paid more than the primary threshold (£157 a week) because above this level employee’s NIC are payable. Any gain in net income has to be considered against the hassle of paying (and deducting) NICs.
In 2017/18 the employee will still be liable for NICs once their earnings exceed £157 a week, but the employer’s NIC liability will be removed by the EA until their sole employee earns more than about £29,903 a year.
Where a non-taxpaying spouse can be legitimately employed in a business, income of up to £11,500 can be paid in 2017/18 (£11,850 in 2018/19) without income tax liability. The payment of remuneration should be deductible for the employer provided reasonable services are provided by the employee – the deduction being based on the “wholly and exclusively” principle. Earnings would need to be restricted to £8,164 to avoid employer and employee NICs.
Such tax planning must always ensure that the spouse’s level of pay can be justified, i.e. in accordance with the work/role they are due to carry out. An increase from, say, £7,500 a year to £29,903 a year just to utilise the EA could well invite HMRC scrutiny. Where the employed spouse has little other income, an increase to make full use of their personal allowance is clearly now much more attractive.
If the director/shareholder was prepared to transfer shares to a spouse, it may be possible to use the spouse’s £5,000 dividend allowance on any subsequent dividend declaration in 2017/18. However, it is important to note that such a transfer must be outright and unconditional.
Pension contributions remain an effective means of reducing tax for the small business. Last year, provisions were introduced to reduce the Annual Allowance for those with adjusted income (AI) in excess of £150,000 and threshold income in excess of £110,000. For somebody with AI of £210,000 their annual allowance reduces to the minimum of £10,000. People caught by this provision should review their level of contributions.
The carry forward rules allow any unused annual allowance to be carried forward for a maximum of three years. Thus 5 April 2018 is the last opportunity to rescue unused relief from 2014/15. With the introduction of a tapered reduction in the annual allowance for 45% taxpayers from 6 April 2017, there is even more reason for directors/shareholders to consider using the carry forward rules in the run-up to 6 April 2018.
As tax year end approaches, there is still time to make use of your available reliefs and allowances.
This tax year end planning checklist covers the main planning opportunities available to UK resident individuals and will hopefully help to inspire action to reduce tax for the 2023/24 tax year and to plan ahead for 2024/25.
As tax rate band thresholds are changing, understanding the impact on high rate taxpayers and the economy is crucial.
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