Do you need the funds in the first place?
There are lots of good reasons why you might need some extra cash, not least meeting your own needs or providing for those around you. However, taking money out of your company is likely to involve both a tax charge and some administrative costs. Once the company has paid corporation tax on its profits it won’t pay tax on its accumulated income unless it invests it into some form of taxable investment (such as a bank account), so you could simply leave the money where it is.
Does the company have the funds?
Your company is a separate legal entity and you and any other directors have responsibilities towards other shareholders, employees, suppliers, customers, and the authorities. Paying you, rather than other stakeholders, could lead to problems of equity or solvency, and specific rules apply to some methods of payment. On the other hand, the company may have lots of surplus cash which could cause a potential problem for its status as a trading company, so passing some to you could be beneficial. Having established that the company has the funds, you also need to consider the tax rate which the company pays as different types of payment to you will impact the company’s tax position.
What types of other income do you have?
Assuming you’ve answered ‘Yes’ to the first two points, you can then consider the effects of a payment on you – how much of any payment will you end up with? If you don’t already receive any dividend income then you can receive up to £2,000 per annum without incurring any tax charge whereas if you’re already using that allowance, dividends will be taxable in full. Similarly, if you don’t currently receive any other employment or self-employment income, then you can receive a salary of up to £9,880 without incurring a National Insurance liability, whereas if you’re already earning above the primary threshold, any further earnings will be taxable.
What’s your marginal rate of tax?
This is where you may need to start using your calculator! Your marginal tax rate is the top rate of income tax which you pay, and dividends are always treated as the ‘top slice’ of your income. It could range from nil to 45% so you need to know what rate of tax is going to be applied to the payment you receive.
If you receive a bonus:
Assuming that you are a director of the company, you will not be subject to the minimum wage regulations, but you should still consider whether the role you perform merits a regular salary and, in particular, whether there is a commercial justification for those payments.
Where a salary or bonus is paid, this will be taxable as earnings, via the PAYE system, at 20% (for basic rate taxpayers), 40% (higher rate taxpayers) or 45% (additional rate taxpayers) and, assuming you’re not exempt, will also be subject to Class 1 NICs at 13.25% (up to your Upper Earnings Limit) and 2% beyond that.
This will need to go through the PAYE system
and the company will be subject to NICs at 15.05%. The good news for the company is that the salary
and NICs are tax deductible for the company, saving corporation tax at 19%. The bonus will constitute earnings for
pensions purposes so may allow you to make additional contributions.
If you receive a dividend:
Assuming you’ve used your dividend allowance, then dividends will be subject to income tax at 8.75% (basic rate taxpayers), 33.75% (higher rate taxpayers) or 39.35% (additional rate taxpayers). Dividends aren’t subject to NICs but neither are they deductible for the company. You will need to include them on your self-assessment tax return and the tax will be payable as part of that return process. The company must have sufficient reserves to pay dividends at the same rate to all other shareholders with the same class of shares, even if those shareholders waive their right to the dividend. A history of paying dividends may have an impact on future valuations of your company’s shares.
Are there other options?
Listed below are other ways in which you could be recompensed for different forms of service which you provide to your company:
- Pension contributions: If the company makes contributions to a pension scheme on your behalf, you’re not subject to income tax if total contributions are within the annual allowance of £40,000 (reduced for those earning more than £240,000). Contributions above the allowance are taxable at your marginal rate. There are no NIC consequences, and the company can deduct the contributions from its trading income, saving corporation tax at 19%.
- Benefits in kind: If you opt to receive benefits, such as a company car or use of a company asset, the value will be subject to income tax as if it were earnings and the company will be subject to Class 1A NICs at 15.05%. The company can deduct the cost of the benefits from its trading income, saving corporation tax at 19%. They will need to complete a form P11D.
- Loan from the company: Generally, the loan itself won’t be subject to income tax or NICs, but HMRC will challenge this if the loan is in anticipation of earnings on which NICs would have been due. If the loan is outstanding more than nine months after the end of the accounting period, the company pays tax at 33.75% although this is repayable when the loan is repaid or written off. If the loan is interest-free or at a low rate, then it is treated as a benefit in kind (see above). If the company writes off the loan, it will be taxable on you as if it were a dividend for income tax purposes but as earnings for NIC purposes and the company will not be able to deduct the amount from its trading income.
- Interest on loan to the company: A savings allowance is available of £1,000 for basic rate taxpayers, £500 for higher rate taxpayers (with nothing for additional rate taxpayers). If your interest exceeds those amounts, it will not be subject to NICs but will be subject to income tax at 20% (basic rate), 40% (higher rate) or 45% (additional rate) and the company will need to deduct 20% tax at source. The company can deduct the interest paid from its trading income, saving corporation tax at 19%.
- Rent paid on assets owned by you but used by the company: This is subject to income tax at 20%, 40% or 45% but is not subject to NICs. The company can deduct the rent paid from its trading income, saving corporation tax at 19%.
Make sure it’s dealt with properly:
While you have some choice over how you are remunerated, you must make sure that the company and you deal with the consequences of that choice. You cannot get to the end of the tax year and then look back and decide how you want your drawings for that year to be treated - the appropriate requirements for declarations of dividends, salary payments and provision of benefits need to be considered at the time of the payment and at the subsequent reporting points.
Conclusion:
Don’t forget that you and ‘your’ company are separate entities – it’s quite right that you’re rewarded for what you contribute and, as the owner manager, you’re likely to have choices about how that’s done, but make sure that you and those running your company understand the consequences of those choices. As always, if you need help in understanding how the principles apply to you or you’d like some of those numbers crunched, get in touch with your usual contact.
Understanding the differences between bonuses and dividends is only one of the areas within business tax planning we can help with.