Tips for shareholders and employees of limited companies for minimising tax
Some background
Remember, that a limited company is a separate legal entity.
That means, that it is legally recognised as being separate from the shareholders who own it. Perhaps the best way to visualise this is to think about a large public company. For example, British Airways. You could buy shares in British Airways and therefore be a shareholder. You could also become an employee of the company and you could become a director of that company. The company could decide to pay you a dividend as a shareholder or a salary/bonus as an employee.
For many people running a small business as a limited company gives them the option to take a combination of salary and dividends. They can take a combination that helps them to minimise the total amount of tax to pay. This is all quite legitimate. However, to maintain their National Insurance contributions record, most directors should be taking at least their annual tax allowance as salary before taking dividends, and those whose contracts are for personal services will be required to take a higher salary.
There are some important points to consider. These notes are intended for general guidance. The rules for calculating tax may change. For specific advice, please contact us at Stephens & Co.
Why you should consider taking dividends
Income tax is a progressive tax. That means that as the total amount of your earnings increases, you will pay a higher rate of tax. Most people have a personal allowance of approximately £4900. This is the amount of money that they can earn in any tax year before they start to pay income tax. Any additional earned income will start to be taxed at 10% and as the amount of income increases, so you will start paying tax at 22% and ultimately 40%.
In addition to income tax, an employee also has to pay National Insurance. This is at the rate of 11%. The employer (the company) also has to pay National Insurance on any salaries or wages that are paid. The employer's rate of National Insurance is 12.8%.
If the company pays you a dividend, that dividend is subject to income tax at 10% provided you are a basic rate taxpayer. The exact amount of income tax will depend on your position and also on the total amount of the company profits. But, in theory, taking a dividend can be much more tax efficient than taking a salary, mainly because you will not be paying any National Insurance.
What is the best combination of salary and dividends for you?
It will depend on a number of factors and you really should ask for our professional advice.
For most people, a salary of approx. £7,500 in any tax year will make certain that they are using up their personal tax allowance and taking advantage of the lower rates of tax and National Insurance. This amount of salary will also mean that you are paying sufficient National Insurance to maintain your entitlement to a basic state pension. It also takes into account the minimum wage requirements.
So, you might think that to minimise your tax you should simply take £7,500 as a salary and that any other money should be paid to you as a dividend. This is fine, if your only objective is to minimise your tax payment.
The timing of payments
If you are being paid a salary, the tax and national insurance is deducted at source. The payment to the taxman has to be made either quarterly or monthly, depending on the total amount of your payroll.
If profits are left in the company these are subject to Corporation Tax (0% on the first £10,000 and then 19% on profits up to £300,000). Corporation tax has to be paid to the tax man nine months after the accounting year end of the company.
As an individual, your personal tax is based on the total amount of your income in each year ending on the 5th of April.
It is often possible for a company to time the payments of salary and dividends so as to minimise the total tax.
Confused?
The tax man certainly doesn't make it easy to understand or to plan.
Essentially, what you are looking to do is to take sufficient salary in each tax year so as to use up your personal allowances and to give you sufficient scope for tax relief on any contributions to a personal pension plan. On top of that, you should take dividends from the company with the intention of remaining a basic rate taxpayer and at the same time, delaying the payment of tax. This is often quite a complex issue and you may want to seek our advice.
You will almost certainly need help with all the calculations and considering what is the best option for you. This is where we come in. Please do not hesitate to call to arrange a meeting.
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