Remuneration planning for owner managed companies

Business owners, directors and shareholders have traditionally chosen to pay themselves by way of a small salary topped up with dividends. Whilst tax should never be the deciding factor in remuneration strategies, it has long been considered the most tax efficient approach.

But, with recent changes to tax rates, should they now reconsider?

The Government has introduced a raft of tax changes that now might leave business owners questioning whether they should be looking at a different way to pay themselves.

Recent changes include:

• An increase in the employees national insurance threshold to £12,500 from 1 July 2022
• The increase in dividend rates by 1.25% from 6 April 2022
• The reduction in the dividend allowance to £1,000 from 6 April 2023 and just £500 from 6 April 2024
• Increases in corporation tax rates from 1 April 2023 which now fall between 19% and 25%
• Increases in pension annual and lifetime allowances to £60,000 per annum and unlimited lifetime from 6 April 2023

Take the example of a company director taking £50,270 in pay with the company making profits of less than £50,000. If taken entirely as salary, the total tax cost to the individual will be £12,064*. If taken entirely as dividends that falls to £3,211.25, and if a mix of salary and dividends it remains at £3,211.25 but with considerable tax savings for the company.

At this level of income and excluding any other potential factors, such as pension contributions or the ability to raise a mortgage, the ‘optimal’ mix at remains a small salary and top up with dividends.

Cost of living increases

Recent inflationary increases and interest rate rises have been felt by most of us, and business owners may wish to increase their pay package to cover those additional costs. But if that increase takes you into a higher tax bracket or over the threshold at which you may have to pay the high-income child benefit charge or lose your personal allowance, how much additional remuneration will you require to fund the additional cash in your pocket you are looking for?

In circumstances where directors have taken a total pay package of £49,000 historically (made up of £12,570 in salary with the remainder taken in dividends) and they receive child benefit for one child, in order to “take home” an additional £5,000 of income per year, the additional costs to the company would be £9,000.

Tax matters

The way a business pays its directors will have major tax implications. It pays to understand those and structure salary and dividends accordingly. Here are some tax points to keep in mind.

Income tax rates, for example, are lower on dividends than on salary, However the ability to pay dividends is dependent on the retained profits, including profits in the year to date, being adequate to cover any dividends.

The company may have to pay employers’ national insurance on salary. There is no employers’ national insurance on dividends. However, the company gets corporation tax relief on salary and employers’ national insurance costs. There is no corporation tax relief on dividends as these come out of taxed profits. Potential increases in corporation tax rates from 1 April 2023 could give greater corporation tax savings on salary.

Other sources of income from outside the business, such as investment property, need also to be considered. Personal tax rates and allowances may be impacted by these and may affect your optimal package. Income from any capital gain should also be considered.

Do you have any capital gains in the year? You may wish to restrict your income to avoid capital gains being pushed into a higher rate tax banding. Bear in mind that the annual allowance has also reduced to £6,000 per annum from 6 April 2023 which means more gains may be taxable than in previous years.

Pension contributions are still tax efficient, and potentially more so than in previous years if your company will be paying a higher rate of corporation tax. The increase in the annual allowance and unlimited lifetime allowance not only offer the potential for increased contributions and corporation tax savings, but also opens up this option to more people. However, this does not provide cash in your pocket.

A complex picture

A company must have enough distributable funds to pay dividends. Low retained profits or losses may prevent a company from paying dividends whereas it may still be able to pay salaries. This is particularly common in the early years of a start-up business.

A remuneration package should be commensurate with the market rate of work being done and could need to be justifiable to HMRC. However this does not include dividends as they are a return on investment so are not limited in same way.

Here are a few other points business owners may want to consider:

• R&D tax relief – If you are able to claim research and development tax relief, salary may be more attractive as the relief may be available on some salary costs.
• State pension – Dividends do not give credit towards state pension. You may wish to consider an adequate salary to provide a year’s credit or pay voluntary national insurance contributions.
• The corporation tax saving on salary and employers’ national insurance is not immediate, it is only realised once the corporation tax is due for payment.
• Personal funding – If needing to obtain a loan or mortgage, lenders may not consider dividends as income, restricting borrowing.
• Insurance products – Do key insurance products, such as Death in Service or Key Man cover, accept dividends as earned income for the purpose of any potential claims.
• Other benefits – You may wish to consider other benefits as part of your remuneration package. Whilst many carry a tax charge, this may be more efficient than paying the full cost of obtaining an equivalent benefit personally.

Whilst there may be an “optimum” package under certain conditions, other factors frequently come into play which means when it comes to remuneration packages there is no one size fits all.

⃰ Scottish rates of tax may be different and may need separate consideration

If you would like help with your remuneration strategy, please get in touch with our team.