The coronavirus pandemic has negatively impacted millions of family companies, reducing and in some cases, eliminating profit entirely.
If there is cash in the business that can be withdrawn, perhaps from one of the Government issued grants or funding options and it needs to be withdrawn to cover living costs, then a lack of retained profits will affect how funds are withdrawn.
No retained profits = no dividends
One of the most popular tax-efficient strategies is to pay a small salary to Directors, then remove any more profits through dividends.
In 2020/21, the most tax-efficient salary where the employment allowance is not available is £9,500, which is equal to the primary threshold for Class 1 National Insurance purposes. If employment allowance is available, then the optimum salary is £12,500, equal to the personal allowance.
Dividends can only be paid from retained profits, meaning if no retained profits are available, then routes other than taking dividends must be used.
Can I pay a higher salary or bonus?
Whilst profits are needed to pay dividends, profit is not needed to pay salaries or a bonus, meaning they can be paid even if this creates, or increases a loss.
Paying an extra amount of salary or bonus will come with a personal tax bill once the personal allowance has been taken up. It will also result in primary and secondary Class 1 National Insurance costs where earnings exceed the thresholds set as £9,500 and £8,788 respectively.
It’s important to remember and take into account that company directors have an annual earnings period for Class 1 National Insurance purposes.
One benefit of doing this is that salary payments and any secondary National Insurance contributions are deductible when working out the company’s taxable profits.
Can I take a loan from the business?
Rather than paying yourself a higher salary, you can also take a loan from the company.
Most family companies are close companies. This means that if the loan is not repaid within nine months and one day of the end of the accounting period that the loan was taken in, a section 455 charge arises. This means that 32.5% of the outstanding balance must be paid by the company to HMRC.
A benefit in kind tax charge will also apply if the loan balance tops £10,000 at any point in the tax year, even if it’s just for a single day.
The amount of tax charged is the interest that would be payable at the official rate (2.25% from April 2020), less any interest that has already been paid.
Taking loans is particularly tax efficient if the outstanding balance is repaid before the section 455 charge.
An optimal time to take a loan would be when there is a difficult period for the business, but a return to profitability is anticipated, meaning a dividend can be declared to clear the outstanding loan balance.
The provision of benefits in kind are also attractive, since the recipient will pay tax on the cash equivalent, rather than meeting the full cost.
Benefits in kind are also attractive when an exemption can be used to allow them to become tax free.
The trivial benefits exemption can also be put to use here, where the cost is more than £50, and then cost of trivial benefits is not more than £300 for the tax year.
In the perspective of the company, Class 1 National Insurance is payable on the cash equivalent amount, but with the cost of the benefit and NIC cost being deductible when calculating taxable profit for corporation tax purposes.
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