Salary and dividends are the traditional way for a business owner to extract value from their business. Due to the tax cost, it is important to carefully consider this to ensure the optimum level of salary and dividends are taken. Employing and giving shares to family can be alternative ways to extract value from a business.

Salary

Generally, a salary should always be taken but kept to a low level.

A minimal salary – above £533 per month (£6,396 per year) – is important to retain access to state benefits such as the State Pension.

Note: From April 2023, the basic rate of income tax will be reduced from 20% to 19%.

There are 2 scenarios:

1. A salary of £823 per month (£9,880 per year) is usually the norm where there are multiple employees and there is enough of the £5,000 employers’ National Insurance “employment allowance” available. There should be no National Insurance contributions payable in this scenario. This amount will increase to £1,047 per month and £12,570 per year from July 2022.
   
   
2. If there is only one employee of the company or if the employers’ National Insurance “employment allowance” is already used or not available, the norm is usually £758 per month (£9,100 per year), again to ensure no National Insurance is payable.

There are lots of exceptions to the norm that can make taking a higher salary more suitable, such as:

• Where you can’t take dividends or have an agreed or fixed amount of value to take out of the business (e.g. directors in investor backed businesses).
  
  
• If you are heavily involved in “Research and Development” your salary can qualify for enhanced relief against Corporation Tax, which makes it more efficient to pay a higher salary (as opposed to dividends).
  
  
• The “Employment Allowance” (a £5,000 allowance against employers’ National Insurance, provided the total secondary class 1 NIC liabilities are below £100k in the previous tax year) can mean a higher salary can be paid without incurring employers’ National Insurance contributions. This could for example make it worthwhile to have a salary of £12,570 – here the only cost would be the employee National Insurance.
  
  
• An employee who is over state pension age will not pay National Insurance contributions. So for example a 68 year old could have a £12,570 salary with no tax or NIC (if the employment allowance is available).
  
  
• If you are looking for a mortgage or to re-mortgage (or other personal loan), some lenders will base their credit scoring on employment income (rather than dividends).

Employing spouse/civil partner, or family member

If they have a lower overall income than you, consider employing a spouse/civil partner or family member so that the company can benefit from the additional resource, the individual can use their personal allowances and/or lower level tax bands, and the company can make a National Insurance saving.

It is important that their pay can be justified in terms of actual activities on behalf of the company.

For a single employee company, employing an additional employee may also make the Employment Allowance available.

Dividends

After salary, the most commonly used method to take the remaining amount of desired cash from the company is via dividends. The first £2,000 of dividends are tax free, so where possible this amount should be taken as a dividend annually.

Above this level, up to £50,270 of total income, the tax rate on dividends is relatively low at 7.5% (8.75% from April 2022, but above £50,270 the methods of taking value becomes much more important. When your total income goes above £50,270 you pay a higher rate of tax, e.g. 32.5% (33.75% from April 2022) on dividends. You could also lose entitlement to certain benefits and allowances, e.g. child benefit, tax free savings allowance is reduced from £1,000 to £500.

Sometimes you may want to take a large amount out of the business, for example for a large purchase. One option could be to vote a dividend. The highest tax rate on dividends is 38.1% (39.35% from April 2022 once total income exceeds £150,000), which whilst lower than the tax rate on a salary or bonus, is still relatively high.

So, before voting a dividend, alternative tax planning options, of which there are many, should be considered with a tax specialist. For example, if a business owner wants to extract funds to invest in property, buy a car, give money to family or start a new business venture, there may be better ways to structure it from a goal, commercial and tax perspective.

Examples of options in this regard are (1) larger pension contributions (e.g. to fund a commercial property acquisition), and (2) family investment companies where the income and gains from the investments can be spread among family members. From April 2023, the rate of dividend tax will be reduced to 7.5% and 32.5% respectively with no additional rate of dividend tax.

Giving shares to family members

If you receive dividends from the company, you should consider giving some shares to your spouse/civil partner if they pay tax at a lower rate than you. This means they will be able to use the £2,000 tax free allowance, and any other lower rate bands than yours.

Away from your spouse, you could also give shares to children (over 18) or other family members, but the capital gains tax position would need to be considered before doing this.

32 Ways To Save Tax and Extract Maximum Value From Your Business

These tips are from our eBook, 32 Ways To Save Tax and Extract Maximum Value From Your Business. This guide explores 32 ways to ensure you’re maximising every opportunity you could be, to improve your life, your families and your employees.

Download 32 Ways To Save Tax and Extract Maximum Value From Your Business eBook.