man and woman walking in city

Cash extraction for business owners

The impact of increases to tax rates

Nick Latimer, Partner, Private Clients and Duncan Hainsworth, Assistant Manager, Private Clients
27/10/2021
man and woman walking in city

As previously announced, in the autumn Budget, Rishi Sunak has confirmed increases to National Insurance and dividend tax rates from 6 April 2022.

National insurance will increase by 1.25% for employees, employers and the self-employed. A corresponding 1.25% increase to dividend tax rates will also be introduced.

This is on top of the April 2023 increase in Corporation Tax announced earlier in the year, seeing tax rates increase from 19% to 25% for companies with profits over £250,000. From this date, companies with profits under £50,000 will still be taxed at 19% with a tapered 26.5% rate for profits between £50,000 and £250,000, with the limits divided between associated companies.

So what impact will this have on the decision of how to extract profits from the family company? Historically, a “low salary, high dividend” strategy produced the best net cash position. Will this still be the case, or going even further, could a partnership/LLP arrangement, which is outside the corporate tax regime, now be more efficient?

The answer, of course, is dependent on the individual’s specific position, however, the effective marginal rates of tax shown below help to demonstrate the impact that these changes may have (the effective rate being for every £100 of taxable profit, the £ tax paid for taking that profit out of the business):

Current Rates 2021/22                                         Self employed/Partner % Salary %                             Dividend %                             Rent/Interest %                     
 Basic rate band 29.00  40.25  25.08  20.00 
 Higher rate 42.00  49.03  45.33  40.00 
Additional rate 47.00  53.43  49.86  45.00 

Increased NICs and Dividend rates 2022/23 

Self employed/Partner % Salary %                             Dividend %                             Rent/Interest %                     
 Basic rate band 30.25 41.98 26.09 20.00 
 Higher rate 43.25 50.67 46.34 40.00 
Additional rate 48.25 55.02 50.87 45.00 

Corporation tax rate 25% 2023-24                     Self employed/Partner % Salary %                             Dividend %                             Rent/Interest %                     
 Basic rate band 30.25 41.98 31.56 20.00 
 Higher rate 43.25 50.67 50.31 40.00 
Additional rate 48.25 55.02 54.51 45.00 

 

Notably, effective rates of tax for director/shareholders of a company paying 25% corporation tax are higher than self-employed rates in all tax bands, and the difference in effective rates between taking a dividend and salary.  These close from 15.2%, 3.7% and 3.6% in 2021/22 to 10.4%, 0.4% and 0.5% in 203/24. Taking profit out of a company by interest or rent (if that is appropriate) is the most tax efficient income tax route in all scenarios.

As effective rates are only the “top line” figures, it is useful to demonstrate the changes by taking a scenario of two director/shareholders. Director 1 takes a salary of £100,000, while director 2 takes a salary below the Class 1 National Insurance thresholds, with remaining profit taken as a dividend.

Under current tax rates, director 2 would have nearly £10,000 more cash in their pocket than director 1. They would also have approximately £4,000 more than a partner/LLP member earning an equivalent level of profit.

Moving forwards to 2023/24, for a company paying 25% corporation tax, director 2’s cash advantage is reduced to £6,000 against director 1, and the advantage over the partner/LLP member is negligible.

Reworking the above example based on a salary of £150,000, 2023/24 rates would see the LLP member’s net cash position overtake director 2 by nearly £6,000.

For owners who have property used by their business, or who have lent money to their company, a further method of cash extraction could be for the company to pay a commercial level of rent or interest. As both rent and interest are deductible for corporation tax purposes and not within the charge to National Insurance, this can certainly prove to be a tax efficient option from an income tax perspective. If director 2 was able to receive interest instead of dividends, they would be more than £11,000 better off than director 1 in 2021/22, and nearly £13,000 better off in 2023/24. There are of course considerations beyond income tax that need to be considered.

Overall, the figures are showing that dividend extraction may no longer be the tax efficient remuneration strategy that it used to be, particularly for those whose income requirements are such that they stray into the additional rate bands. However, there are large range of factors to consider with regard to remuneration planning, and the difference between corporate and non-corporate structuring – these include methods of profit sharing within the family, tax on the use of vehicles, tax credits for R&D expenditure, amongst many other things. Advice is therefore essential to develop an appropriate structure and strategy.

For more information on the issues raised in this article or to discuss your circumstances, get in touch with Nick Latimer or your usual Crowe contact.

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Nick Latimer
Nick Latimer
Partner, Private Clients
Cheltenham