As we covered in our blog “What you need to know - Running your own company”, owners of limited companies will often look to optimise their tax position by taking their income as a mix of salary and dividend.
This is standard practice for hundreds of thousands of owner-managed limited companies across the UK.
Research conducted by the Federation of Small Businesses (FSB), shows that well over 900,000 UK limited companies manage their personal income in this way. The tax benefits have been significantly eroded in recent years, but a salary-dividend mix remains the most tax-efficient way to take regular earnings from your limited company.
More specifically, the best mix has always involved a small salary, which is topped up by dividends.
The salary is set at the maximum allowed by prevailing National Insurance (NI) allowances, without actually triggering any payment of NI.
This allows owner-managers to continue to accrue their entitlement to the State Pension benefits, whilst also maximising the tax relief that is available in any given tax year.
The easiest analogy is that of VAT, where zero-rated sales still have VAT applied to them, but at 0%. An optimum salary-dividend mix means that National Insurance is being paid, but at 0%, while those payments receive tax relief in the company.
It is always worth considering that dividend is not available to make pension contributions and was excluded from the COVID Furlough calculations.
National Insurance Thresholds
The amount of salary that can be taken from the business is governed by National Insurance thresholds.
There are several different thresholds in force at any one time, each triggering a payment of a different ‘type’ of national insurance and, historically, it has been what is referred to as the Secondary Threshold that has dictated the ‘best’ salary that a director-shareholder should take.
But from 6 July 2022, the Secondary Threshold will be superseded by a rise in the Primary Threshold, meaning that it will be the Primary Threshold that will dictate the optimum salary.
This has the effect of increasing the optimum director’s salary from £9,100 per year to £11,908 for the tax year ending 5 April 2023.
The optimum annual salary actually increases to £12,570, but as the relevant National Insurance threshold is (unusually) changing during the tax year, £11,908 is the optimum amount for the 2022/23 tax year (on a pro-rata basis).
The increased salary can be claimed from 6 July 2022.
Because of the way that limited companies and directors are taxed, this will mean an overall tax saving of almost £200 per year, increasing to around £210 in 2023/24.
Crucially, provided that there is no contract of employment in place, this increase will not trigger auto-enrollment obligations for single director companies, even though national insurance will now be paid.
But, please read the small print.
The small print
You may have heard the saying, “there is no such thing as a free lunch”. Well, this is an example of exactly that.
The saving is real, but there is a catch.
The saving comes with a cash flow hit.
For the current tax year, the actual saving available is £191.21. This is made up of an increase in National Insurance contributions of £422.60, but a reduction in Corporation Tax of £613.82.
The challenge is that National Insurance is payable monthly, and Corporation Tax is payable 9 months after the company’s financial year-end.
In other words, you will have to pay around £35.22 each month in National Insurance and wait until 9 months after your financial year-end to see the reduction in your Corporation Tax payment (unless you usually choose to pay your Corporation Tax earlier).
Put simply, it is spending £35.22 each month to see a saving equivalent to £53.65 per month, but as a lump sum, much later on.
It does work out as a healthy return of 45% if viewed as ‘savings’ - but these are savings that you cannot access immediately. They are locked away.
Every situation is different, so talk to us about your position as another important factor is if your limited company has losses that it is carrying forward against its Corporation Tax. In this instance, adjusting your salary may not be the best option.
Does this mean I can take more money from my limited company?
Yes, but don’t think of the increase in salary as a ‘pay rise’.
Rather, you are transferring some of your income from dividend to salary and saving £191.21 in tax - which you can take from the company if your cash flow allows.