Spotlight on…Tax Rates for Business Owners

Why is it relevant?

The recent introduction by the Chancellor of the Health and Social Care Levy at 1.25% increases the rate of tax on dividends by 1.25% as well as both National Insurance contributions by employees and employers by the same.

The effect of the introduction of the Health and Social Care Levy is to increase the effective rate of tax for both a salary and dividends. From 1 April 2023 Corporation Tax also potentially increases to 25%. All these factors need to be considered carefully on deciding on how to withdraw funds from a business in the coming months.

The changes impact both dividends and salary and the tables below set out the effective tax rates on each £100 of profit realised by the company depending on whether it is withdrawn as dividend and or salary in the current and two following tax years:

DIVIDENDS

SALARY

The effective rate of tax remains slightly less for dividends and therefore the position has been for some time that most owner managers remunerate themselves with a small salary to utilise their personal allowance and then additional amounts are drawn as dividends, where company circumstances permit.

Further consideration also needs to be given to the impact of the increase to Corporation Tax from 2023 and this is why bespoke advice may be needed.

Who is it relevant to?

Businesses owners who draw a salary and/or dividends from their business.

What do you need to know?

There are a number of potential remuneration strategies to mitigate the impact of these new taxes. We explore three of these below, but the position and interaction of the issues means each company will be in a unique position and an individual discussion should take place as soon as possible:

1. Personal pension contributions: Currently contributions to personal pension plans can be made by companies for business owners without attracting National Insurance and receiving a Corporation Tax deduction. While there are limits on the amounts that can be contributed this is an obvious alternative to the tried and tested dividend route which would allow profit extraction with a lower effective tax burden, while acknowledging that these are funds that the business owner is unlikely to be able to utilise for several years.
2. Drawing additional funds documented as loans: The new Health and Social Care Levy will also increase the tax rate paid by companies on loans to directors/employees (often referred to as the s455 liability) by 1.25% to 33.75%. This tax is paid should a loan to a business owner not be repaid within nine months of the accounting period in which it is made. The tax is repaid by HMRC once the loan is cleared, but the repayment would also be nine months after the end of the period in which the loan is cleared. Therefore, while there would potentially be a significant cashflow impact on the business, it may be tempting for owners to draw additional funds from the business and have these documented as loans and wait and see how tax rates change over coming years before deciding how best to remunerate themselves.

3. Withdrawing larger salaries or dividends: Business owners may also choose to withdraw larger than normal amounts from their business in the form of salary or dividends in order to utilise the current tax year lower tax rates as described above. If that has the impact of leaving their business with reduced working capital, then there is no restriction on the business owner making an advance of some or all of these funds back to the business. i.e., they provide funding to the business. So long as there is sufficient cash flow to allow the initial bonus or dividend to be paid there are no adverse tax consequences to this.

However, the business owner needs to be aware of the risk that this money is most likely to be an unsecured creditor and could be at risk should the company fail. If this route is utilised an additional benefit is that the business owner can charge interest on the loans. This interest, so long as the interest rate is an appropriate market rate, can be paid by the company without any National Insurance or Health and Social Care Levy but still be deductible for Corporation Tax purposes.

What should you do next?

Given the nature of the changes it is key to consider the appropriate strategy for the business. It is also essential that payments are physically made and properly documented to make the planning undertaken effective. We recommend you discuss the impact of the Health & Social Care Levy on your business and the strategies you might employ to mitigate the costs as soon as possible, so please get in touch with your usual Blick Rothenberg contact or Marc Levy, using the form below or the contact details in his profile.