Remuneration planning

For a number of years it has been the norm for the working shareholders of owner managed limited companies to remunerate themselves by a small salary supplemented by regular dividends. Get the balance right and significant national insurance savings can result.

For example, a gross salary of £50,000 actually costs a limited company £43,980 as you add employer’s national insurance of £5,670 but then allow for corporation tax relief of £11,690. The £50,000 salary results in net income of £35,808 for the recipient after allowing for income tax and employee’s national insurance.

However, if a salary of £5,700 per annum is paid instead, supplemented by regular dividends totalling £30,108, the same net income is achieved. The cost to the company in this case is £34,611 comprising £5,700 less corporation tax relief of £1,197 plus the dividend.

This leads to a saving for the company of £9,369 predominantly due to the avoidance of both employer’s and employee’s national insurance. This saving can be passed on to the shareholder although this may lead to additional income tax.

Some have taken this a stage further by introducing spouses or civil partners as shareholders. Individuals can currently earn up to £43,875 before becoming subject to higher rate tax. So if their income is above this limit and some can legitimately be diverted to their spouse via dividends, higher rate tax equivalent to 25% of the dividend received can be avoided.

There are a number of issues to take into account when considering remunerating by dividend including:

1. Availability of reserves from which to pay the dividend;
2. Ensuring that the dividends are correctly declared;
3. The national minimum wage legislation; and
4. Ensuring that the company does not fall under the special rules applicable to ‘personal service companies’.

Given the potential savings that can accrue from avoiding national insurance, dividends are well worth considering.

The reserves problem is something that has started to cause problems for some companies already paying by dividend. As a dividend is a distribution of profit rather than an expense, there must be profits from which to pay the dividend.

Where income has fallen significantly during the recent downturn, or perhaps bad debts have been incurred, the ability to pay dividends can be compromised. What should be done about this will depend on how quickly you believe the company’s fortunes will recover.

If the forecasts indicate that reserves will recover in the short term, you might consider simply deferring income or perhaps taking short term loans from the business However, this in itself needs careful consideration as company loans to shareholders can be a tax minefield.

If it appears that reserves will not recover in the short to medium term, then swapping to salary, with its related additional national insurance costs, may be required. However, it may be time to consider whether a limited company is the right structure for the business.

If you would like further information regarding this area of planning, please contact Darren Austin on 01892 772960.