Family companies: assess profit extraction strategy

Corporation Tax

The main rate of Corporation Tax is 25% for companies with profits of more than £250,000. A small profits rate of 19% applies to profits of £50,000 or below. Where profits are between the two, Corporation Tax is paid at the main rate reduced by marginal relief. This provides a gradual increase in the effective Corporation Tax rate. In all, higher Corporation Tax rates and marginal relief may mean new choices for profit extraction.

Tax efficient remuneration

Traditional remuneration strategy involves a small salary and extracting remaining profits as dividends.

Salary: this is usually set at a level sufficient to qualify for state benefits (notably State Pension entitlement) but pitched so that no liability for NICs arises. Salary counts as a deductible business expense for Corporation Tax purposes, as do employer NICs. Unless a director has a contract of employment that means they are a ‘worker’, there is no need to pay minimum wage hourly rates.

For 2023/24, the preferred salary in many cases will be £12,570, so that the standard personal allowance is fully used. NICs for directors are calculated based on an annual earnings period on salary and bonuses. Though employer NICs kick in at £9,100, employee NICs are due on earnings over £12,570, with a further 2% charged above the upper earnings limit of £50,270. We can help you review an appropriate figure for salary to suit your circumstances.

Dividends: The dividend allowance continues to fall, whilst the rate of tax on dividend income has increased. This means that extraction of profits through dividend payment has become more expensive. Whilst in many cases, it may still be tax efficient to take profits as dividends rather than salary, the decision is becoming more nuanced.

Bonus: In some cases, it may be more efficient to extract profit as a bonus, for example where there are not sufficient retained profits out of which to pay a dividend at the required level, or where Corporation Tax is paid at the full rate.

Like salary, bonuses are subject to Income Tax and NICs for the director, and employer NICs for the company. The cut to employee Class 1 NICs from 12% to 10% from 6 January 2024, will make payment of a bonus less expensive. The full effect of the reduction will only be felt from 6 April 2024. For 2023/24, directors will pay a ‘blended’ annualised NICs rate of 11.5%.

The rules around timing can sometimes be used to advantage. For Corporation Tax, bonuses can be decided after the end of the company year, when final results are known. They are still deductible in that year if paid within nine months. For Income Tax, there is scope to defer taxation of a bonus into a later tax year, or include in the current tax year, depending on how and when the bonus is declared. It is important to get the timing and procedure correct, and we can advise further.

Consider how to deal with directors’ loans

It is common for director-shareholders in family companies to have a loan account with the company. As most family companies are what are technically called ‘close companies’, this brings them within scope of the ‘loans to participator’ rules. This can mean a charge to Corporation Tax, often known as a s455 charge, if a director’s loan account is unpaid nine months after the end of the accounting period. For loans made on or after 6 April 2022, the charge is 33.75%.

A benefit in kind, subject to Income Tax and NIC, may also apply where a commercial rate of interest is not paid on an overdrawn director’s loan account.

Please do talk to us about the options for dealing with a director’s loan in your circumstances.