As an owner-manager of a small business, your main concern will be making your business profitable and building up cash reserves in the company. But you'll also want to be able to extract funds from the business too - whether this is via a regular monthly salary, or ad-hoc dividend payments.
Salary vs dividends is the most common split, but there are a number of different ways of extracting funds from your business, all of which can have different tax and capital impacts - both for you personally and for the company as a whole. Because of this, it's important to have a clear and workable remuneration strategy - which clearly sets out how and when you will be able to take funds out of the company.
Building a tax-efficient remuneration strategy
Once your business is financially stable, you'll no doubt have thought about how to take income from the company, particularly how to split income between salary and dividends. So, what are the main considerations when creating a remuneration strategy?:
- Your first choice is generally to ask 'How much should I take as a salary?'. Presuming that you don't have a contract of employment with your company (most owner-managers don't) then the National Minimum Wage legislation doesn't apply.
- To build up credits (contribution years) for the state pension, your salary has to be paid at a rate that's equivalent to at least the Lower Earnings Limit (LEL) of £520/month. Generally, therefore, a salary of at least that amount should be taken.
- Individuals pay National Insurance (NI) contributions at a rate of 12% on salary between £797 and £4,189, and at 2% on salary in excess of that level. So, these NI deductions need to be factored into your strategy.
- The company will have to pay Class 1a and 1b employer NI contributions at a rate of 13.8% for all salary above £737 per month. But these contributions may be partly or fully covered in some circumstances by the NI employment allowance.
- There's a 'sweet spot' between £520 and £737/£797 where no NI is payable by either party, which can be a big factor in the amount of salary you pay out. This sweet spot is also below your income tax threshold as an individual - you're actually considered to be a contributor to earn state pension benefits and the salary is deductible against the company's profits for corporation tax purposes.
- Above this sweet-spot level, it's sensible to consider whether or not to take dividends. Bear in mind that dividends can only be paid out of after-tax company profit, so your business does need to have delivered this profit before you can extract any cash as a dividend payment.
- The first £2,000 of dividends are tax-free for the recipient, but above that the rate depends on which tax band the dividends fall into. If you have any unused personal allowances then dividends that fill that gap are tax-free.
- Dividends in the basic-rate band (generally total income between £12,570 and £37,700) are taxed at 7.5%. Dividends in the higher-rate band are taxed at 32.5% and anything above that is taxed at 38.1%.
- Other ways in which funds can be extracted from the company include paying off amounts due on any director's loan account, making a loan to you as a director (which can have other consequences), making contributions to your director's pension fund and providing benefits in kind.
- As with all of these things, the driver behind your remuneration strategy needs to be the needs of the business, not the short-term, positive tax implications for you personally. There will always be specific considerations to factor in for each scenario and each individual - so it's good practice to talk to your accountant in advance of extracting any funds from the business.
Talk to us about your remuneration strategy
In most cases, there's no shortcut to crunching the numbers when it comes to creating a robust remuneration strategy. It requires an excellent understanding of both company and personal tax, and a good knowledge of the complex (and sometimes opposing) effects that company and personal taxes can have on each other.
We'll help you to review your business and private wealth situations and generate a remuneration strategy that's tax-efficient, straightforward and well-suited to your cash needs.
How we can help
- Give you personal tax advice
- Create a remuneration plan for you and/or your staff
- Prepare income tax returns
- Prepare monthly/weekly payslips and take of your PAYE tax compliance duties