When trying to extract funds from a family company, there are a number of factors that need to be considered. For instance, the most efficient route will depend on the differing rates of income tax, corporation tax, national insurance contributions (NICs) and capital gains tax (CGT).
From 6 April 2011 the rates of Class 4 and Class 1 NICs increased by 1% while on 1 April the main rate of corporation tax fell by 2% and the small profits rate decreased by 1%. Income tax rates remain unchanged. Here we consider what the changes could mean for family companies.
Bonus versus dividend
Salary or dividend – each has its merits.
From the company perspective, money paid by way of a bonus or salary is deductible for corporation tax purposes. However the company, as employer, is also liable to pay employer’s NICs (13.8%). The bonus or salary is taxable in the hands of the recipient (under PAYE) and primary Class 1 NICs are also payable.
Dividends, meanwhile, are paid out of retained profits and as such they are not deductible for corporation tax purposes, but there are no NICs to pay on dividends. Further, there is no additional tax to pay when received by a basic rate taxpayer. Higher and additional rate taxpayers effectively pay tax at the higher or additional dividend rates of 32.5% and 42.5% respectively (extra tax of 25% and 36.11% of the net dividend).
When paying dividends it is important that the company has sufficient distributable profits and dividends are properly declared in accordance with company law requirements. Dividends have to be paid to shareholders in the ratio that they hold shares unless there is a waiver or different classes of shares. Bonuses can be allocated as the directors wish.
To maintain benefit and state pension entitlement, it may be advisable to pay a small salary of between the lower earnings limit and secondary threshold for NIC purposes (between £102 and £126 per week for 2011/12).
Impact of tax rates
Falling corporation tax rates (26% main rate and 20% small profits rate from April 2011), and rising NI rates, swing the pendulum in favour of dividends. From April 2011, the combined rate of employer and main rate employee NICs (13.8% + 12%) is higher than the small profits rate of corporation tax (20%) meaning that the NIC savings associated with a dividend outweigh the loss of corporation tax relief.
Capital versus income
Although options for extracting profits in the form of capital may be limited, with CGT rates currently at lower levels than income tax rates, combined with the availability of the CGT annual exemption, where the opportunity to withdraw capital is available, this is likely to be an attractive option from a tax perspective.
For more information Peter can be contacted on 0161 761 5231 or email peter.nicol@horsfield-smith.co.uk. Professional advice should always be sought as individual circumstances may differ.
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