It is important that profit extraction strategies for owner-managed companies are reviewed on a regular basis to take in to account changes in circumstances and in tax rates and rules, writes Pearson May partner David Richards.
The advent of a new tax year is often an opportune moment to review one’s tax affairs generally and to take suitable action in light of any changes to various tax rates and thresholds etc. 
Salary
It has in the past been common practice for directors/shareholders of ‘one-man companies’ (or companies that are owned and managed by more than one individual e.g. husband and wife companies) to pay themselves a salary sufficient to gain a ‘credit’ for their NI contribution record and ‘top up’ their income with dividends from the company.
To maintain one’s NI contribution record for 2017/18, a salary of at least £490 per month should be paid (that being the ‘Lower Earnings Limit’ for NI purposes) but it is usually better to pay more than that, up to approximately £680 per month, since any salary up to that level does not incur any NI costs but still contributes to your NI record for state pension and other benefits purposes.
Any salary paid above this level will attract NI contributions that will be payable to HM Revenue & Customs. Employee’s NI is payable at 12% on earnings above £680 per month (with a further 2% payable for higher-earners) and Employer’s NI is payable at 13.8% on earnings above the same threshold (but see below regarding the NI Employment Allowance).
Company directors can therefore pay themselves a salary of £8,160 for 2017/18 without incurring any Income Tax or NI liabilities and the salary is usually an allowable expense for Corporation Tax purposes
Dividends
The introduction of the annual dividend allowance from April 2016 means that the first £5,000 of dividend income, per individual, is tax-free. However, dividends received above this level are now taxed at the following rates:
7.5% for basic rate taxpayers
32.5% for higher rate taxpayers
38.1% for additional rate taxpayers
Prior to April 2016, dividends received by basic rate taxpayers did not suffer any additional income tax charge for the individual, so these changes have meant that some director/shareholders who have historically received a low salary and high dividends will see an increase in their tax liabilities for 2016/17 onwards.
Each individual’s circumstances will vary but certain director/shareholders may want to consider increasing their salaries slightly and reducing dividends. This is particularly the case where the NI Employment Allowance is available to the company, whereby the first £3,000 of any Employer’s NI in the tax year is waived.
However, Employee’s NI is still payable above the relevant threshold (see above), so this needs to be considered carefully when deciding upon the level of salary and dividends to be paid. Those over State pension age won’t be liable to Employee’s NI so they may want to consider increasing their salaries further.
It should also be noted that the criteria to be met in order to claim the NI Employment Allowance are not straightforward in some cases. It cannot be claimed by companies where there is only one director and no other employees. There are added complications where there is more than one director (or a director and other employees) as it may then be available but will depend on the level of salaries paid to the directors and employees.
What other options are there?
Consideration could be given to the company making employer pension contributions in to a pension scheme for directors. Although this will usually mean the individuals cannot access the funds straightaway, it is a tax efficient means by which to extract profits from companies (since such contributions will usually qualify for Corporation Tax relief). The Annual Allowance for pension contributions is currently capped at £40,000 per individual. However, if you have been an active member of a pension scheme in previous years and have not made full use of the allowance in more recent years, you may be able to use those unused allowances now. Advice should be obtained from your pension adviser or an independent financial adviser in this respect, as the rules are not straightforward.
Where a director/shareholder has a credit balance on his loan account with the company, opportunities can arise for the payment of interest by the company, which should qualify for Corporation Tax relief in the company. The first £1,000 of interest received by individuals per tax year is free of tax for a basic rate taxpayer, with the excess being taxed at the individual’s marginal rate of tax. Depending what rate that is and the size of the loan account, this could be a tax-efficient method by which to extract profits from the company.
As mentioned above, each individual’s circumstances will be different and specific advice is therefore essential. If you wish to discuss your tax affairs and those of your company we would be pleased to hear from you.
The above is for general guidance only and no action should be taken without obtaining specific advice.
