Extracting company profits: what are the options?
Company directors have 3 main options when taking profits from their companies. These are salary, dividends and an employer pension contribution. Each of these options is taxed differently with regard to the company and the individual.
Changes to corporation tax and the taxation of dividends were announced or confirmed in the Autumn Statement in November 2022 and this case study looks at what it will mean for company directors from 6 April 2023.
| Company tax and National Insurance | Individual tax and National Insurance | |
|---|---|---|
| Salary | Employer National Insurance dependent on the level taken. No corporation tax. |
Income tax dependent on the level taken. Employee National Insurance dependent on the level taken. |
| Dividends |
Corporation tax.
|
Income tax at the dividend rates.
|
| Employer pension contribution |
No corporation tax.
|
No income tax until benefits are taken.
|
From April the rate of corporation tax is 25% for companies with profits over £250,000.
The current rate of employer National Insurance is 13.8% for earnings above £9,100 per year.
The current rate of employee National Insurance is 12% for earnings between £12,570 and £50,270 and 2% for everything above £50,270.
The maximum salary possible without paying any National Insurance contributions (Employer National Insurance threshold) is £9,100.
The dividend allowance (the amount of dividends you can take before tax is due on them) reduces from £2,000 to £1,000 from 6 April 2023 then reduce again to £500 from 6 April 2024.
Any employer pension contribution should satisfy the wholly and exclusively for the purposes of the business rule in order to receive Corporation Tax.
Case study – options from 6 April 2023
The following case study will help show how much an individual would receive after tax and National Insurance using one of their options or a combination. We’ll assume there is profit of £400,000 to be extracted with £100,000 being paid to each individual. They are all resident in England for tax purposes.
Mrs Cynic needs income and is looking to take on a mortgage in the near future. So, she chooses to take all of the £100,000 as salary. Her salary has been calculated so that the salary and employers National Insurance amount to £100,000.
Ms Maximiser is 60 and is looking to boost her pension savings. She decides to pay the full £100,000 as an employer contribution into her pension and take the tax-free cash immediately. She has unused annual allowance from previous years to carry forward to avoid any annual allowance tax charge. Assuming she is a basic rate taxpayer in retirement and 25% tax-free cash is taken, she will ultimately receive £85,000 (£25,000 plus 80% of £75,000).
Miss Spendnow is looking to maximise her immediate income as well as take enough salary to receive credit towards her state pension. The Corporation tax is calculated on 25% of £100,000 less salary of £9,100.
Miss Livzalife is looking to pay the maximum into her pension without paying a tax charge. This is £60,000 as she has no unused annual allowance to carry forward. She would also like to receive enough salary to receive credit towards her state pension. She takes the remainder as dividends for her immediate income needs. The dividend is £100,000 less salary of £9,100 and £60,000 pension contribution and the Corporation tax is calculated as 25% of this.
Assuming she is a basic rate taxpayer in retirement and 25% tax-free cash is taken, she’ll ultimately receive £51,000 from the pension (£15,000 plus 80% of £45,000). This reduces the amount extracted by £6,000.
Find all the figures together in a table below:
| £100,000 profit for each individual to extract from the company | Mrs Cynic Salary only |
Ms Maximiser Pension contribution only |
Miss Spendnow Salary and dividend |
Miss Livzalife Salary, pension and dividend |
|---|---|---|---|---|
| Corporation tax | - | - | £22,725 | £7,725 |
| Employer NI | £11,023 | - | - | - |
| Salary | £88,977 | - | £9,100 | £9,100 |
| Income tax | £23,023 | - | £12,325 | £1,637 |
| Dividend | - | - | £68,175 | £23,175 |
| Employee NI | £5,298 | - | - | - |
| Employer pension contribution | - | £100,000 | - | £60,000 |
| Profit extracted | £60,656 | £100,000 (£85,000) | £64,950 | £90,638 (£81,538) |
Every business owner has choices to make and numbers to be crunched which will mean the best decision based on their circumstances and need for income. The best option or combination of options will depend on their age, their need for immediate income, their available annual allowance, their National Insurance record and mortgage situation.
It’s also good to have a discussion with any accountancy connections as pensions are often overlooked, especially those for spouses in a business who have director duties. The days of large pension contributions in the year of retirement have gone, and pensions should be considered earlier to provide the best retirement outcome for your clients.
Disclaimer
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.