From 6 April 2018, the dividend allowance, that has been £5,000 since it was introduced, reduced to £2,000. So how will this affect owner managed businesses and profit extraction from their companies for 2018-19 onwards?
Updated data for 2018-19
From 6th April 2018: -
- The personal allowance rises to £11,850
- The basic rate tax band rises to £34,500
- The dividend allowance reduces to £2,000
- National insurance for employees and directors (class 1) changes to the following
- Lower earnings level - £6,032 p.a.
- Primary threshold - £8,424 p.a.
- Upper threshold - £46,350 p.a.
- National insurance for the self-employed changes to the following
- Class 2 NIC is £2.95 per week
- Class 4 NIC is aligned to the class 1 threshold of £8,424 p.a. and is paid at 9% on any excess up to the Upper Threshold of £46,350
- The Class 4 NIC Rate above the upper threshold is 2%
Let’s see how the new rules affect those businesses (sole traders and partnerships) that may be looking to incorporate.
Historically this became worthwhile (purely from a tax perspective) when profits reached circa £25,000 a year.
A sole trader with profits of £25,000 in 2018/19 will only save around £700 in tax and NIC by incorporating (assuming they are extracting profits in the most tax efficient way). The additional compliance costs of operating through a limited company once incorporated is likely to far outweigh these tax savings and therefore not worth the change purely for tax savings reasons.
Once profits get to £50,000, the tax savings are approximately £2,000 making incorporation more attractive, but due to the changes to dividend tax this is no longer a one size fits all solution.
The savings continue as profit levels increase, but not indefinitely. At £70,000 of profits, the tax saving is £2,380 but above this level if profits are fully withdrawn, the savings start to contract.
Above this level, the key to further savings depends on the ability to utilise the family unit to take advantage of lower tax bands and rates.
Marital Tax Break
The married couples allowance as a tax break is limited, with the maximum savings being just £237. Involving a spouse in a clients’ business is much more tax efficient – with the opportunity to utilise two personal allowances and basic rate bands.
If you are already incorporated, we need to determine the optimal balance of salary and dividends from a tax perspective.
Single Company director / shareholder
As can be seen from the above, if the salary is taken at the personal allowance level, the calculations show a worse position by £232. So, the optimum position for 2018-19 is to set the salary at the NIC primary threshold of £8,424.
If the employment allowance is available, a salary at the personal allowance level is the best option but only gives a saving of £28.
Some other strategies that could be used to increase profit extraction in a tax efficient manner from a compony include: -
- Smoothing – the company may provide the ability to “smooth” the tax payable on profit extraction - by possibly deferring the taking of dividends into a later tax year.
- Making use of a spouse as a fellow shareholder – to make use of lower tax bands if possible.
- Paying a commercial rate of interest on any directors’ loan account that is in credit with the company
- Using the company to make pension contributions on your behalf
The above information is based on our current understanding of tax law and practice – this can be subject to change without notice.
Of course, your own individual circumstances need to be considered when planning for any of the above so please contact us for tailored individual advice.