Hi

Shareholder/directors of small companies generally make profits to extract the money and spend it, but how the funds are extracted will affect the company’s taxable profits. Salary and pension contributions will reduce taxable profits, but dividends won’t.

The first rule of profit extraction planning is to work out how much the business owners need to spend and when. Traditionally a small company director would take a minimum salary of around the secondary threshold for national insurance contributions (NIC), and any extra funds required as dividends. Dividends are still taxed at the low rate of 8.75% within the basic rate band (much higher rates in other tax bands), but the dividend allowance will be cut to £1,000 in 2023/24 and just £500 in 2024/25. 

The tax and NIC burden on the director’s salary needs to be balanced against the CT rate payable if the company’s profits fall into the marginal relief band. The employer’s NIC payable on that salary may be partially or wholly covered by the £5,000 employment allowance where the company employs someone other than the director.

If the director doesn’t need the funds immediately, employer pension contributions should be considered. The increased pensions annual allowance of £60,000 will allow higher regular pension contributions and any unused annual allowance from the previous three tax years can be carried forward to use in the current year. As long as the total remuneration package including pension contributions is reasonable for the work performed by the individual, HMRC will not challenge the deduction of those contributions. 

With the removal of the pension lifetime allowance, the amount that can be efficiently invested in pension funds is unlimited, but be aware that the Labour Party has promised to reinstate the pensions lifetime allowance if/when it gains power. 

If you are in doubt about whether you have the optimal profit extraction strategy contact your accountant as soon as possible.

Noel Guilford