How to extract cash tax efficiently from your business
With the increases in National Insurance and Dividend Tax looming, now is the time to think about how cash is extracted from your company tax efficiently ...
Pension Age Directors
When deciding on profit extraction methods, the toss-up between dividends vs salary often comes down to the amount of National Insurance Contributions due. However, when you reach pension age, employee National Insurance Contributions (NICs) are no longer payable, resulting in more money in your pocket from salary and eroding the advantage of dividends. While the company still has to pay the employer’s NICs both the salary and NICs are deductible for Corporation Tax purposes.
As a basic rate tax-payer, typically a dividend is still slightly more tax efficient, as the lower Income Tax rates provide slightly more relief than the Corporation Tax savings provided by a salary. However, the difference is minimal and may be lost altogether if you are able to claim the Employment Allowance. For higher rate taxpayers the advantage of dividends over salary is even smaller.
There are circumstances where dividends can’t be paid or where it is not desirable to do so, such as if the company is loss-making or has external shareholders where the intention is to direct profits based on the performance of owner-managers rather than all shareholders. Therefore, now may be the time to review the numbers and consider a change in approach.
Tax Efficient Bonus
A Corporation Tax (CT) deduction is available for a bonus once there is an obligation to pay it; a vote in principle just before the accounting period ends will usually, therefore, secure the deduction. However, the bonus must be ‘paid’ (in this case the recipient becomes entitled to the bonus even if the cash has not physically changed hands) within 9 months of the accounting period end otherwise the CT deduction is denied. This timing allows for the CT deduction to occur in one accounting period with the associated PAYE and National Insurance (NI) liabilities not falling due until the following accounting period, creating a cash flow advantage.
However, with the increase in NI rates from April 2022, companies whose total Class 1 NI bill is close to but not over the Employment Allowance threshold (£100,000) may wish to bring bonus payments forwards. Once the EA threshold is breached the EA is no longer available in the following accounting period. For companies who are already close to the threshold, the increase in rates plus bonuses may cause them to breach; paying bonuses earlier and/or spreading them over two years could help to keep the Class 1 NI bill under that EA threshold for an additional year.