Introduction »

How to get it out

Recent Finance Acts and Budget proposals may have left many owner-managers feeling a bit hard done to. A top rate of tax of 50% from April 2010 and proposals to increase all rates of national insurance contributions (NIC) from April 2011 send shivers down the spine. So, what is the best way to get your hard earned cash out of a company?

Many owner-managers pay themselves a basic salary and perhaps use tax efficient benefits, such as employer provided childcare vouchers or employer pension contributions (subject to the new, complex, rules on pensions introduced from April 2009).

For many years, higher rate taxpayers have been subject to a special tax rate of 32.5% on their dividend income. This combined with the fact that many companies only pay tax at the small companies rate means it is often beneficial to extract profits using a dividend rather than additional remuneration in the form of a bonus. This dividend rate rises to 42.5% (50% for other income) from April 2010, for those with a taxable income in excess of £150,000.

Example - for a 40% higher rate taxpayer

Christie is to receive a bonus of £60,000 after all taxes from his family company. He is a higher rate taxpayer for 2010/11. This means that he will pay 40% tax on any additional earnings. In addition as he has existing earnings above the employees’ upper earnings limit for NIC purposes any bonus will be liable to employees’ NICs at 1% only.

Company

The cost to the company of paying a dividend will be £80,000 whatever the CT rate.

The company will have to pay employer’s NIC of £13,017 on the bonus making the gross cost £114,712. The net cost will depend on the rate of CT paid by the company and the comparison is as follows:

And what changes if the 50% rate arises?

Derek is to receive a bonus of £60,000 after all taxes from his family company. He has a marginal income tax rate of 50% (42.5% for dividends) for 2010/11 and already has earnings above the employees’ upper earnings limit for NIC purposes so that any bonus will only be liable to employees’ NICs at 1%.

Company

The cost to the company of paying a dividend will be £93,913 whatever the CT rate.

The company will have to pay employer’s NIC of £15,673 on the bonus making the gross cost £138,122. The net cost will depend on the rate of CT paid by the company and the comparison is as follows:

And don’t forget loans!

Under the post 6 April 2010 regime, some thought might be given to making use of loans rather than dividends. Based on the current rules, there are no plans to increase the 25% rate of tax due from a company, when a director/shareholder is given a loan advance - commonly in the form of an overdrawn current account.

Even if income tax and NIC is due under the benefits rules for cheap loans, loans to owner-managers may still prove to be a more attractive temporary option than a dividend payment. The rate of official interest on such a loan is currently only 4%!

So, a loan of £93,913 to the owner of a small company may create a tax bill for the company of £23,478. In addition an annual employment benefit of £3,756 may arise (4% of £93,913) which is then subject to tax at perhaps 50% (£1,878) plus 12.8% employer NIC (£480). The total taxes at this stage are £23,478 + £1,878 + £480 = £25,836 which is less than an outright dividend payment. There is no employee NIC.

If the loan is waived, the corporation tax of £23,478 is repayable. Instead there is now a charge to tax and NIC (employee and employer) on the amount waived on the individual directly. For tax only, the amount charged is at the relevant dividend rate, so could be 42.5%. However, the waiver can be at a time of the individual’s choosing so, maybe that rate will have been abolished by then – you never know!

As there are lots of options please do get in touch before taking any action.

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