Dividend and Salary

Transcription

1 Dividend and Salary

2 What are the best Directors Salary and Dividend Levels for 2016/17 Q. I am a contractor freelancer operating through a limited company and I use the low salary and dividend combination of extracting money from my company. In previous tax years I have made sure that I stayed below the higher tax threshold so that I didn t have any income tax to pay on my dividends, however with the changes to how dividends are taxed from April 2016 with the introduction of the Dividend Allowance, I am unsure if this is still the best strategy. Can you advise what the best mix of salary and dividends is for the 2016/17 tax year i.e. from April 2016? A. The 2016/17 tax year has brought with it some major changes to how dividends are taxed which in turn has an effect on the optimum tax planning positions for directors who are also shareholders. The dividend changes from April 2016 have been covered by us in a previous article but we will outline the position again in this article. Before getting into the detail we should say that this article is based on what is currently known at the date of publication which is 10th February There is a budget announcement due on 16th March 2016 and whilst there are no anticipated changes due which would affect the advice in this article, if anything does change we will update this article accordingly.

3 How dividend taxation worked before the 16/17 tax year There used to be something called the dividend tax credit which meant that from a personal tax perspective a dividend had to be looked at gross, whereas from the company that was paying the dividends perspective the dividend was seen as net. The dividend tax credit was 10% and an example of how this worked was: Company pays a cash dividend of 1,000 This is grossed up by 10% by calculating 1,000 divided by 0.9 = 1, It is the grossed up figure that is used for personal tax calculations. As long as your personal total income including gross dividend income was below the higher tax band ( 42,385 for 15-16) then there was no personal tax to pay on your dividends. If you went over the higher tax band then the element of dividend in the higher tax band was taxed at 22.5% of the gross dividend (which was effectively 25% of the cash dividend). There were also additional tax rates at the upper rate of tax as well as other things that could affect personal tax including child benefit. How dividend taxation works from the 16/17 tax year (from 6th April 2016) The dividend tax credit has been scrapped, this makes it easier to understand in our opinion. A new dividend allowance has been introduced which means that an individuals first 5,000 of dividends are tax free. Over and above this 5,000 the dividend income is taxed as follows: If you have any un-used personal allowance ( 11,000 for 16-17) then that element is tax free. Any dividends in the basic tax band (up to 43,000 for 16-17) attract a tax charge of 7.5%. Dividends above the basic tax band are charged at 32.5%. Additional rates of tax will apply at the upper tax band ( 150,000 for 16-17).

4 Optimal levels of salary and dividends for Now we have explained how dividends will be taxed from 16-17, we need to look at what the most tax efficient levels of salary and dividends are. Taking a low basic salary with the balance of income being extracted as dividends is a common strategy amongst limited company contractors, freelancers and small business owners. The theory is as follows: Take a low salary no higher than the personal allowance so that it does not attract personal tax Make sure the salary is high enough for national insurance purposes i.e. that it counts as a years stamp for your national insurance history to help protect your future entitlement to state pension and benefits The salary is a tax deductible expense for your business so corporation tax is saved at 20% on the gross salary. Additional money is extracted as dividends which does not attract national insurance, therefore you are not paying any more national insurance than you need to be. Bear in mind that dividends are not a pre-tax expense for companies so you do not save corporation tax on dividends. The question is then, what is the optimal level of salary? The introduction of the Employment Allowance in April 2014 (it is being increased to 3k from 2k in 16/17) means that it is slightly more tax efficient to take a gross salary to the tax free allowance level ( 11k for 16-17), however HMRC have announced that from 16/17 the Employment Allowance will not be available to companies where the only person on the payroll is a Director, i.e. single director employee limited companies. Unfortunately, what they have left open as a grey area is the situation where there is a husband and wife who are both directors taking a salary with no other employees. As things stand it would appear this would be ok, however it is clear that HMRC s intention is to block companies that have no real employees from claiming the employment allowance. Our stand on this currently is to lean on the cautious side and only take the employment allowance if you are employing people other than connected Directors. So for a husband and wife only company we would suggest to not claim the employment allowance. Equally for contractors we would therefore suggest not taking the employment allowance. We are hoping for clearer guidance to come from HMRC at which point we may change our position, however for now we are playing it safe and it also keeps things a bit simpler. With this in mind, we have outlined two different salary and dividend options which are put together on the basis that you wish to stay below the higher tax band ( 43k). We have made some key assumptions when preparing these calculations: No student loan balance Your only income is your salary and dividends from your company You are not caught by IR35 You have a standard personal allowance Your company has sufficient post tax profits to support these dividends

5 Option 1 claim the employment allowance (if allowed), more tax efficient with a little more admin Take an annual gross salary of 11,000 which is the standard tax free personal allowance for Your personal allowance may be a bit different if HMRC have adjusted your tax code but to keep it simple we ll assume the standard 11,000. This level of salary will not attract any personal income tax, but it will attract some Employees National Insurance which will total No Employers National Insurance will need to be paid as it will be covered by the Employment Allowance. If you have other employees you will need to consider if their salaries already use up the 3k employment allowance, if they do then you would be better going for Option 2 (see next page). With regards to dividends, the higher tax band is 43,000 so assuming you want to stay in the basic tax band this leaves you 32,000 of dividends to take. There will be some personal tax to pay on these though, as the first 5k is tax free but after that is charged at 7.5% tax. See below table for illustration: Tax year Annual Gross Salary 11,000 Dividends 32,000 Total Gross Income 43,000 Employee NIC (355) Tax on dividends (2,025) Net cash in pocket 40,620 Any dividends taken above the higher tax band will be taxed at 32.5% and even higher if you trigger other tax tipping points such as the child benefit charge at 50k, 100k tax free allowance withdrawal and the upper tax band at 150k.

6 Option 2 take a salary up to the NI Primary threshold If you can t claim the employment allowance or want to keep things a little simpler this is a good strategy for you. There are two National Insurance thresholds you need to be aware of: Lower Earnings Limit as long as you earn above this you are protecting your entitlement to future state pension and benefits, without necessarily paying any National Insurance, leading us on to Primary Threshold if you earn above this you have to start paying National Insurance. So the sweet-spot is to go up to the Primary Threshold but no higher. The National Insurance Primary Threshold for 16/17 remains the same as 15/16 at 155 per week or 8,060 for the year. Therefore we would suggest a monthly Gross Salary of 670 which stays just below this threshold. With regards to dividends, assuming as with Option 1 you wish to take dividends up to the higher tax band but no further, then you can take slightly more dividends with Option 2 than with Option 1. This is because you are only taking just over 8k of salary which leaves almost 3k of dividends that are in the tax free allowance, as well as the 5k tax free for the dividend allowance. See below for how this works out with regards to tax it is the same tax amount but the dividends are higher Tax year Annual Gross Salary ( 670 x12) 8,040 Dividends 34,960 Total Gross Income 43,000 Employee NIC 0 Tax on dividends (2,025) Net cash in pocket 40,975 You will note that the net cash in pocket after income tax and employees NI is actually slightly higher in Option 2 than 1 by 355, however this doesn t factor in the additional corporation tax you save on the higher Gross Salary in Option 1. See the summary section (opposite) for a table which compares the two options side by side and considers the corporation tax effect as well.

7 Comparison See below for a table which compares Options 1 and 2 and shows that overall Option 1 is more tax efficient by Tax year Annual Option 1 Option 2 Gross Salary 11,000 8,040 Dividends 32,000 34,960 Total Gross Income 43,000 43,000 Employee NIC (355) 0 Tax on dividends (2,025) (2,025) Net cash in pocket 40,620 40,975 Corporation Taxe saved on Gross Salary 2,200 1,608 Overall savings of Option For contractors and freelancers, Option 2 is the recommended route and also has the added benefit of being able to get a bit more personal cash in pocket despite costing a little more corporation tax. Option 2 also has the added benefit of being less admin intensive as no NI needs paying over to HMRC. Tax planning ideas Here are some tax planning ideas you might want to consider to help reduce the impact of the dividend tax changes, these should be discussed with your accountant: Transfer a minority shareholding to your spouse so they can receive up to 5k of dividend tax free. Set up a rental agreement with your company for claiming use of home as office expenses. Company pension contributions (speak to a pension advisor as various rules to consider).

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