Year End Tax Planning Series – Family Companies: Assess Profit Extraction Strategy

Welcome to the next instalment of our year-end tax planning series, in which we are sharing our expertise about how you can best prepare for a successful year-end and new-year planning period. In this article, we are talking about family businesses, of which there are around 4.8 million in the UK. In particular, we are shining some light on profit extract strategies to ensure you get the best value for your taxes and meet regulations.

There’s a changing outlook for director-shareholders in family companies. Recent developments, such as changing the Dividend Allowance and National Insurance contribution (NICs) rates and potentially higher corporation tax rates, all mean remuneration may need rethinking. Checking the numbers in your particular circumstances becomes increasingly important. Keep reading to learn more.

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 become higher. 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 it 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%.

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

Keep up to Date With Pension Planning Opportunities

It’s been a year of significant change for pensions, with developments impacting high earners and workers over 50, in particular.

• From 6 April 2023, the Annual Allowance (AA), increased from £40,000 to £60,000. The AA is the maximum tax-relieved pension saving that can be made each year without attracting a tax charge.
• Change around limits for the tapered AA. From 6 April 2023, the tapered AA applies where adjusted income (broadly net income plus employer pension input) is more than £260,000 (up from £240,000) and threshold income (broadly net income less pension contributions) is more than £200,000. For every £2 of adjusted income above £260,000, the AA is tapered by £1, until it reaches a specified minimum.
• From 6 April 2023, the minimum tapered allowance is £10,000, rather than £4,000.
• From 6 April 2023, the Money Purchase Annual Allowance is £10,000, rather than £4,000. This lower AA applies where someone has flexibly accessed a defined contribution pension.
• The Lifetime Allowance (LTA) charge was abolished from 6 April 2023, and the LTA itself was abolished from April 2024. The LTA has capped the total amount that could be built up in tax-relieved pensions savings. Until 5 April 2023, it was, in most cases, £1,073,100, though a higher limit applied where there was LTA protection.
• Excess lump sums above the LTA are now taxed at the marginal rate of income tax, (rather than a 55% tax charge).
• The Pension Commencement Lump Sum (the maximum tax free payment available on first accessing pension benefits) is now set at £268,275, except where protections apply.

Whilst welcome news, the tax position of high earners continues to be complex, and we would recommend reviewing the position on an individual basis. It is worth mentioning that pension planning for Scottish taxpayers can only become more significant with change to Scottish income tax rates and bands projected from 6 April 2024.

Making pension contributions remains one of the most tax efficient ways to invest for your future. Whether you are a director-shareholder, self-employed business person or partner, we would be happy to discuss this area with you further.

Receive Tax Planning Support From Hysons

After reading this article, we hope you have plenty of ideas for managing profit extraction from family companies. To learn about any of these points in detail or discuss anything we have not included in these passages, please contact us.

This article touched on corporate tax investments, but in the next article and the last of our series, we will share our insights about personal tax investments. Be sure you are following us to learn about the launch of our final chapter in this written series.