Once a decision has been made to withdraw funds from the company, it is necessary to consider how to do that. There are many possibilities. For director-shareholders of personal service companies, the most relevant choices are:
1. Directors’ remuneration and bonuses.
2. Paying salaries to other family members.
3. Pension contributions.
4. Tax-efficient benefits in kind.
5. Dividends.
6. Extracting funds through a loan account.
7. Liquidation of the company.
Each of the these carries a different tax liability so it is important to work out which approach, or combination of approaches, is best in any particular situation. Sustainability, simplicity and ease of administration are also important to many people.
Other obligations are also relevant, including the need for the company to comply with legislation relating to the national minimum wage and the national living wage. For employees aged 25 or more, the NLW replaced the NMW from April 2016. It is currently set at £7.50 per hour.
The interaction between the NLW/NMW and NIC must be considered. For 2017/18, the weekly threshold for NIC for both employers’ and employees’ contributions is £157. The NLW regime therefore carries with it an NIC obligation in respect of most full-time employees.
Once director-shareholders have received the NLW, and any required tax-efficient benefits and pension contributions have been paid or made available, then the realistic ongoing choice for further extraction of funds from the company will often be between bonus on the one hand and dividends on the other. Because of the NIC liabilities attaching to bonuses, dividends will often be preferable. However, to avoid a challenge from the National Insurance Contributions Office, it is important that all the correct procedures for payment of a dividend are followed. It is also prudent to consider the impact of an individual’s low earnings/high dividend profile on their ability to meet the requirements of a mortgage lender.
Budget
The 2015 summer Budget introduced a new regime for the taxation of dividends. This took effect in April 2016. From that date, basic-rate taxpayers pay 7.5 per cent income tax on dividends. Higher-rate taxpayers pay 32.5 per cent while additional rate taxpayers pay 38.1 per cent. A dividend tax allowance was also introduced, exempting the first £5,000 of dividend income from tax. In the March 2017 Budget, the tax-free dividend allowance was reduced to £2,000 with effect from 2018/19. In the worst case, this reduction will mean that individuals see their taxes on dividends increased by around £1,100. For couples who have organised their tax affairs based on the 2015 rules, this could double to £2,200 of extra tax.
To illustrate the differences, here’s a simple calculation for 2018/19 for England and Wales. Don’t forget that the Scottish rate of income tax is now different:
