Each year it is important for business owners to review the company remuneration strategy to determine the most tax-efficient way to withdraw money from the business. Unfortunately, a number of business owners view the contents of the business bank account as their own and not as a separate entity, resulting in the failure to consider the tax implications of withdrawing money from the business until after the fact.
Due to ever-changing tax legislation, it can be difficult for business owners to keep up with what is not only tax-efficient, but also legal. Recent reports show that business owners are increasingly falling into the trap of drawing illegal dividends.
Illegal dividends arise when a company has insufficient distributable profits to cover the sums of money it has declared as dividends to its shareholders, and it is imperative to ensure that a review of the distributable profits has been carried out prior to declaring dividends.
So, what is the best remuneration strategy then?
Whilst it has generally been accepted that taking a small salary and topping up with dividends has been the most tax efficient remuneration plan, this will not always be the case following recent legislative changes and therefore tax efficient remuneration planning should always be carried out ahead of any decisions being made.
Below we explore the two most common methods that money can be withdrawn from the business:
Taking a salary
A salary is a common method of withdrawing money from the business. For this, the company will need to register a Pay As You Earn (PAYE) scheme with HMRC and submit payroll reports to HMRC. Depending on the level of salary, the company may have to pay employers National Insurance Contributions (‘NIC’), and the individual may have to pay income tax and employee NIC.
Taking a small salary enables an individual to maintain their National Insurance record for state pension eligibility. However, the optimal salary level will differ depending on the individual’s other sources of income. As such, further advice in this area should be sought.
A small salary is often not sufficient to cover outgoings, so what else can we do?
Dividends are payments that are made from the company’s distributable reserves and are paid to shareholders. Often, dividends will be declared on a quarterly or annual basis, forming a significant part of a remuneration plan. Dividends are subject to lower rates of income tax and, unlike salaries, cannot result in NIC falling due.
Therefore, by taking a combination of a small salary and dividends, the tax liability paid by the individual could be less than that of opting for a salary-only remuneration package.
However, these are not the only considerations to be made when looking at a remuneration package, and it is the combination of salary and dividends that often results in people falling into the trap of declaring illegal dividends.
But wait…there’s more!
Remuneration packages aren’t limited to salaries and dividends, but can also include the following:
- Pension contributions
- Employment benefit packages
- Directors loans – drawdowns on directors loans are subject to other tax considerations which should be considered prior to utilising a loan facility
These areas are complex and come with their own tax implications, therefore you can quickly find yourself overwhelmed with information if you try to tackle this alone. Additionally, remuneration packages are an area that HMRC often raise enquiries into for the purpose of tax avoidance.
The good news is that our expert team here at AAB are on hand to guide you through this and help develop a bespoke and tax-efficient remuneration strategy for you that is in line with your personal and professional goals. If you would like further information on how we can assist with your remuneration strategy, or assist with responding to an enquiry from HMRC with regards your remuneration strategy, please do not hesitate to contact Michaela McCombie or your usual AAB contact.