The way in which you run your business will affect the amount and type of tax and National Insurance that you pay. When deciding on an appropriate structure for a business, the tax and National Insurance regime under which the business operates is one of the factors that should be taken into consideration. This means that there are many effective ways to extract cash from your company as an owner.
The following is an article direct from our best-selling Tax Efficient Ways to Extract Cash from Your Company
, which has been recently updated to reflect current legislation and law change. This special report reveals a number of strategies to help extract profits from a company in a tax-efficient manner.
Optimal Salary Level
When deciding on what level of salary to pay, it is important to remember that while there are some general rules, there is no `one size fits all’. Assuming that the director’s personal allowance is available and not otherwise utilised, the optimal salary will depend on whether or not the employment allowance is available. The employment allowance is set at £3,000 for 2018/19 and, where available, will shelter employer Class 1 NICs, which would otherwise be payable up to this level. However, not all companies can benefit from the allowance as it is not available if the company is a personal company where the sole employee is also a director.
Employment allowance not available
In the case of a one-man company, which is unable to benefit from the employment allowance as the only employee is also the director, it makes sense to pay the director a salary of between the lower earnings limit and the primary and secondary NIC threshold (which for 2017/18 is between £6,032 and £8,424 a year)Where a small salary is paid which falls between these limit, there will be no actual NIC to pay. However, the director is treated as if he has paid notional contributions at a zero rate on earnings that fall between the lower earnings limit (£6,032 for 2018/19) and the primary threshold (£8,424 for 2018/19). These notional zero rate contributions have the effect of maintaining the director’s contributions record and ensuring that the year is a qualifying year for state pension and benefit purposes.
Although salary is taxable pay, assuming the director is entitled to the basic personal allowance, set at £11,850 for deductions in his PAYE code, no tax will be deducted under PAYE -- this is because a salary at this level is below the PAYE threshold. At the end of the tax year, however, this pay will be taken into account when calculating the director’s overall tax bill for the year under self-assessment. For 2018/19, the primary and secondary thresholds applying for employee Class 1 National Insurance purposes are aligned at £162 per week (£702 per month, £8,424 a year). Consequently, the maximum amount that can be paid without triggering a tax liability for the director (assuming the personal allowance, or at least £8,424 of it, is available) or a NIC liability for either the director or the company is £8,424 for 2018/19.
Remember, directors have an annual earnings period for NIC purposes. This is useful, as even if the salary in some months is more than £702, as long as the annual salary is not more than £8,424 no National Insurance will be payable. This allows flexibility to pay different amounts at different times. However, if salary in any month is to exceed £702, the director would want to use an annual earnings period from the outset rather than calculate the liability for each pay period with a recalculation on an annual basis when the last payment in the tax year is made. In conclusion, where the employment allowance is not available (as would be the case for a one-man company), the optimal salary level for 2018/19 is £8,424.
Withdrawing further salary in excess of the primary and secondary threshold will attract a NIC liability for both the director and the company. Even where the additional salary remains covered by the director’s personal allowance, the NIC cost (@12% for the employee and13.8% for the employer) outweighs any corporation tax saving (@19% for the financial year 2018). The exception to this is if the director/employee is under the age of 21 as no employer contributions are due on earnings below £46,350 (2018/19 level), and in this situation, the optimal salary is at the same level as that where the employment allowance is available, as explained below.
Employment allowance available
The availability of the employment allowance impacts on the calculation of the optimal salary level and makes it tax and NIC-efficient to take a higher salary, as long as the available employment allowance is sufficient to shelter the employer NIC liability that would otherwise arise. The employment allowance is set at £3,000 for 2018/19 and is available to (most) companies with more than one employee and to single employee companies where that employee is not also a director. Where the employment allowance is available it can be beneficial to pay a salary above the primary threshold. If the personal allowance is not used up elsewhere (for example, by rental or investment income), for 2018/19 it is advantageous to pay a salary equal to the personal allowance of £11,850.
Although the director will pay NIC to the extent that the salary exceeds the primary threshold (£8,424 for 2018/19), there is no employer’s NIC to pay as the employer’s NIC that would be payable at a salary of this level (£4,727.79 for2018/19, being 13.8%(£11,850 - £8,424)) is offset by the employment allowance. Although the director will have to pay some employee’s NIC at this level, the employee’s NIC paid by the director is more than offset by the corporation tax deduction available for the additional salary paid in excess of the primary threshold.
For 2018/19, a director will pay employee’s NIC of £411.12 on a salary of £11,850 (12%(£11,850 - £8,424)) compared to nil on a salary equal to the primary threshold of £8,424. However, the additional salary paid in excess of the primary threshold of £3,426 (£11,850 - <£8,424) is deductible for corporation tax, generating a further corporation tax deduction of £650.94 (£3,426 @ 19%) (financial year 2018 rate). The effect of the employment allowance means that it is possible to save £239.82 (£650.94 -£411.12) by paying a salary equal to the 2018/19 personal allowance of £11,850, rather than paying a salary equal to the 2018/19 primary threshold of £8,424. The saving of £239.82 is 7% (£11,850 - £8,424), 7% being the difference between the corporation tax rate of 19% and the employee NIC rate of 12%.
Director is under the age of 21
The same calculation as that used above where the employment allowance is available applies if employment< allowance is not available but the director or employee is under 21. In this case, no employer’s National Insurance will be due on a salary equal to the personal allowance of £11,850 for 2018/19 as no secondary contributions are payable on the earnings of an employee/director under the age of 21 until earnings exceed the upper secondary threshold for U21s, set at £892 per week for 2018/19 (£3,863 per month, £46,350 per year). The same is true in relation to apprentices under 25. Where this is the case, this will be the optimal salary level, rather than one equal to the primary threshold of £8,424 for 2018/19. Paying a salary in excess of the personal allowance. Is it worth paying a salary higher than one equal to the personal allowance of £11,850 for 2018/19? The answer is `it depends’ and the answer will depend on the amount of profits to be extracted, whether the employment allowance is available, and the director’s marginal rate of tax. There is no substitute for doing the sums.
Generally, however, where the salary exceeds the personal allowance, any further salary will suffer tax at the basic rate (at 20%) and employee’s National Insurance (at 12%), even if no employer’s National Insurance is due. The combined tax and employee hit at 32% is more than the associated corporation tax saving (at 19%), so once this level is reached, other extraction methods may be preferable to take advantage of allowances and lower tax rates. A point to bear in mind is that if the director is a basic rate taxpayer and in receipt of the marriage allowance (£1,190 for 2018/19) such that his or her personal allowance for 2018/19 is increased to £13,040 and the employment allowance is available, it will be beneficial paying a salary equal to the higher personal allowance for the reasons outlined above.
However, where a spouse or civil partner is unable to fully utilise his or her personal allowance, a better option would be to employ them within the company if this a practical option, to enable all rather than only 10% of their personal allowance to be used to shelter profits extracted from the company. However, as always, while the maths may work from a tax perspective, there may be non-tax reasons why the director may not want to go down this route and, as always, the tax tail should not wag the proverbial dog.
By Sarah Bradford
This is an excerpt from our popular report Tax Efficient Ways to Extract Cash From Your Company For more information, click here.
This article was first printed in Business Tax Insider in August 2018.