If you are a company owner/director you probably don’t need reminding that we live in a constantly changing world of pension and tax regulations. That said, how confident are you that you have acted to ensure you are managing your personal and business tax affairs efficiently in light of recent changes? Below we have listed a few things to consider when talking to your tax advisors.
If you take dividends, you have just a few weeks to save future tax – don’t assume that because the new regime affects the year from 6th April 2016 there is nothing you can do now. Instead take the opportunity to both act now and plan ahead. Regardless of when your company year end is, if you have sufficient funds (after corporation tax liabilities have been considered), award yourself higher dividends before the 31st March and save dividend tax that will be payable next year.
New tax on dividends – what does it mean for you as a company owner/director?
At the moment your dividend income (payments you receive as a company shareholder paid out of your company profits after you have paid corporation tax) is not taxed so long as your total personal income, including the dividend payment, does not exceed the basic rate personal tax bracket threshold of £31,785.
From 6th April 2016 these rules will change and you will pay more tax on dividends no matter what tax bracket you are in. Next year only the first £5,000 of dividend income will be untaxed, with the rest up to the basic rate personal tax threshold being taxed at 7.5%, rising to 32.5% for higher rate and 38.1% for additional rate tax payers. (Current year rates are: 0%, 32.5%, 37.5%)
For example if in the current year your only income is a combination of a small salary of £8,000 and dividends of £15,000 (total income £23,000), but you can afford to pay an additional dividend of £8,000 (taking your income up to £31,000) and you then reduce your dividend next year by the same amount (i.e from £15,000 to £7,000), you would save 7.5% tax on the additional £8,000 dividend (£600) as compared to paying equal dividends in both years.
You can award yourself any dividend up to the limit of your company’s reserves as at 31st March 2016 (reduced by any corporation tax liability not yet paid). If you are a basic rate taxpayer, to maximise your benefit you should award yourself a dividend equal to the difference between the basic rate tax limit (£31,785) and the total of all your other personal income including salary. If you don’t have the cash flow to pay that amount of dividend, consider loaning the company the cash to pay the increased dividend.
If you are already a higher rate tax payer, considers the pensions options below.
Dividends vs salary – which should you pay yourself as a limited company owner-manager?
Most shareholding company directors running their own limited company will have been advised by their tax accountants to draw a small annual salary of around £8,000 to £10,000 as this has the benefit of not attracting payroll taxes while still counting toward your National Insurance record for State Pension purposes, so that you get a full state pension when you retire.
From 6th April 2016, when the new dividend tax comes in, the mix of a small salary and dividends is still going to be the best option, although unfortunately with the new dividend tax you will pay more taxes.
For people in the higher tax brackets it is still beneficial to keep your total personal income below £100,000 and assuming your only source of income is from your business the vast majority of this should be paid in dividends – with income above £100,000 you start to lose your personal tax allowance.
Company owner/directors – why should you consider paying a pension from your company?
You are probably aware that pension rules have been changed significantly and that now, once you are 50 you can withdraw money from your pension fund to spend as you wish, including up to 25% of the total fund tax free. The rest when drawn will be treated as personal income and subject to tax rules as with any personal income.
There are some advantages in paying a pension from your company. The most obvious is that it reduces your corporation tax bill, as company pension payments are deducted as a company expense and not taxed as personal income until drawn (see above).
If your company is claiming Research and Development (R&D) tax credits and some of the R&D is done by you, there is an even greater benefit because the company pension payments are treated as salary under the R&D tax credit scheme. So let’s assume in the year starting 1st April 2015, you spent 25% of your time on R&D projects and the company paid £20,000 into your personal pension fund. The £20,000 pension payment will offset £20,000 pounds of profit which at the 20% corporation tax rate gives a tax reduction of £4,000. In addition 25% of the pension payment is counted as R&D costs, which gives rise to a further tax reduction of £1,300 (26% of the relevant R&D costs) so the total corporation tax reduction as a result of the £20,000 pension payment is £5,300, which is 26.5% of the pension payment.
This article has been written to highlight potential action and plans. We strongly recommend that you seek professional advice before taking decisions on your business and personal tax affairs, as each situation is different and your particular circumstances and requirements need to be considered.
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