Using the personal allowance
Making use of the personal allowance (PA) for all family members is always prudent. It can be especially beneficial where an individual has no other taxable income and has perhaps routinely carried out work for the business on an informal basis in the past.
Salaries paid at a level realistically reflecting the duties carried out, and made for the purposes of the business, will also attract a corporation tax deduction. Care will be needed to set a salary at an optimal level with regard to National Insurance thresholds. National Minimum/Living Wage requirements and pensions auto-enrolment may also need consideration. Payment should be formally recorded, as should hours worked.
PA is reduced where total income is over £100,000, by £1 for every £2 of income above this limit. Careful thought should thus be given to deferring such income as you have discretion over - bonus payments and dividends potentially falling into this category. Holding such payments back until the new tax year may produce a more favourable outcome.
Dividend payment has traditionally been part of the profit extraction strategy for director-shareholders. Most family companies will pay directors a minimal salary – preserving state pension entitlement, but below the threshold at which National Insurance contributions (NICs) are due – with the balance extracted as dividends. The saving in NICs here can be considerable.
Dividends have their own tax treatment. In 2018/19, tax is paid on dividends at 7.5% for basic rate taxpayers; 32.5% for higher rate taxpayers; and 38.1% for additional rate taxpayers. Taken in conjunction with the Dividend Allowance, £2,000 for 2018/19, this can be very favourable. However, company profits taken as dividends remain chargeable to corporation tax:19% in 2018/19, falling to 17% from 1 April 2020.
Planning for Child Benefit Charge
Where someone receives Child Benefit, it is important to remember that although dividends are taxed at 0% within the Dividend Allowance, they still count as income when it comes to High Income Child Benefit Charge. Taking dividend income could potentially trigger an unexpected charge here, and we would be happy to advise further.
The timing of dividend payments to shareholders is important, and again the question is whether to make payment before or after the end of the tax year. A dividend payment in excess of the Dividend Allowance, delayed until after the end of the tax year, may give the shareholder an extra year to pay any further tax due. The deferral of tax liabilities on the shareholder depends on a number of factors. Please contact us for detailed advice.
Timing is important with directors' bonuses, too. Should a bonus be timed before or after the end of the tax year? The date of payment will affect when tax is due, and possibly the rate at which it is payable.
Bonus or dividend
Careful judgment may be required when deciding whether a bonus payment or dividend is more tax efficient. Bonuses are liable to employee and employer NICs. For Scottish taxpayers, a further point to consider is that bonuses are now taxed at Scottish rates of income tax as employment income, but dividends are taxed at UK rates as savings income.
Please do contact us for a review of your individual circumstances.