One of the most useful ways for owner directors of small companies to reduce their overall tax and NIC costs is to pay themselves a reduced salary – just enough to maintain their State benefits entitlements – and take any balance of remuneration in the form of tax efficient benefits and dividends.
Government has changed the rules regarding the sacrifice of salary in exchange for benefits, so this particular tax planning strategy has shorter legs, however, the advantages of dividends as a tax efficient remuneration strategy remains; albeit with reducing benefits in future tax years.
Why is this?
Dividends are not a cost. They don’t reduce the amount of profit assessable to corporation tax. Rather, dividends are a distribution of profits after corporation tax has been deducted. Presently, company reserves available for distribution in this way have already suffered a potential 19% corporation tax charge. Accordingly, only 81% remains. This can be retained to finance future investment, or accumulated as a rainy-day fund to see you through more difficult trading periods, or it is available to distribute to shareholders as dividends.
Consequently, the withdrawal of dividends creates no tax consequences for the company, but it can create income tax bills for shareholders.
For 2017-18, the following rules apply. Shareholders will pay:
No tax on the first £5,000 of dividends received from all sources.
7.5% tax on any dividends that form part of their basic rate band.
32.5% tax on any dividends that form part of their higher rate band, and
38.1% tax on any dividends that form part of their additional rate band.
If the missing parts of the Finance Bill 2017 are reintroduced after the June election, the £5,000 tax-free allowance is being reduced to £2,000 from April 2018.
The arguments in favour of the low salary high dividend approach for owner directors of small companies is well known and in most cases, an appropriate, and acceptable, tax planning strategy. Unfortunately, every person’s tax affairs are unique, and whilst the generalisations made above hold good for most shareholder directors, what is less clear – and should not be generalised – is the best-fit strategy to suit your particular circumstances.
The tax regime for dividends looks to be hardening in future years, so if you haven’t discussed your options recently, a conversation is probably overdue; and of course, we can help.