Optimal CT/Dividends/Pay split for Ltd. company?

Question

I'm looking for views on what the optimal split should be for a Ltd. company in the following scenario in terms of corporation tax paid, dividends paid and wages paid, and also if it's possible to legitimately reduce CT.

Scenario: Ltd. company, 1 paid employee, 100K profits before salaries paid, reducing company account balance to zero at any time is viable.

The advice received so far is to pay the 1 employee a small salary, e.g. 10K to keep up NI contributions but to keep the payments to a near minimum, and then some or all of the remainder in dividends.

I understand the logic of the small salary, and my understanding is that if 10K salary is paid then CT would then be due on the 90K and some or all of the remainder could then be paid in dividends. I believe that dividends can also be paid in advance of year end.

I'm wondering though whether there is ever an advantage in paying more basic salary to reduce the amount liable for CT, or whether the increased NI liability and basic rate taxation would be more than the saving from paying lower CT.

It was interesting to learn recently of the VAT fiddle that some large stores do by claiming that some figure, e.g. 2.5%, on credit card purchases was the merchant account transaction fee, even though the figure is typically lower. As these fees are aparantly VAT exempt, the company thus reduces VAT liability by 2.5%, something that is (arguably rightly) contested by HMCE.

This had me wondering if there are ways to reduce CT that small companies can take advantage of. e.g. can a company buy an employee something that the employee wanted personally to reduce the company profits, although as this would presumably need to be declared on the p11d it would be taxed as if it were salary and so achieve nothing except extra paperwork. Presumably NI isn't paid on benefits though? I remember company car schemes being popular, and when working at Chemical Bank I had a 6K 'car allowance' bonus, but then heard that car schemes are no longer popular although am not sure why. Is that type of thing beneficial, or being eligible for dividends, is that still the best route?

In summary, what is the best possible way to split profit into income streams to the director/employee.

Any thoughts, differences of opinion and words of wisdom are welcome!

nick

Ronald Raygun · Accepted Answer

I take it the sole employee is also the owner entitled to receive the dividends.  "Optimal" is to be interpreted in the way that will result in as much of the £100k as possible ending up in that person's hand after all tax is deducted. It is usually recommended to pay salary equal to the income tax threshold (£4615) which accords NI credit with no actual NI becoming payable.  Neither is IT payable. Above that, IT kicks in at 10%, with NI kicking in above £4628 at 21.1% (11p employee's NI per nominal pound earned, plus 12.8p employer's NI per nominal pound earned, but of course each nominal pound costs the employer £1.128; so 23.8p/112.8p = 21.1%). Total deductions per £1.128 are 12.8p employer's NI, 11p employee's NI, 10p income tax (rising to 22p above nominal salary of £6575), so the effective marginal rate of taxation even at the low end of the scale (between £4628 and £6575) is 30.0%, rising to 40.6% above £6575.  However, at the £100k profit level, the marginal CT rate...

Robin Cox · Answer

One advantage of a higher salary is in order to fund a pension - there is normally a funding limit based on a %age of salary. Low salary is tax efficient but may only allow small pension contributions.

Dividends can be paid at any time, provided that they are paid out of profit. Bear in mind that if the grossed up dividend income added to your other gross income exceeds the higher rate tax threshold, you will have to pay higher rate tax on (some of) the dividends. Might be better to draw dividends just before the end of the tax year in order to use up your basic rate band, and keep the undistributed profit in the company.

Are you outside of IR35?

If not, that will blow a big hole in your plans.

Robin

Nick · Answer

Thanks for the replies. A good point, but IR35 isn't an issue.  Nick

Jonathan Bryce · Answer

If the company is on the higher marginal rate - 33.75%, and the person receiving the dividends / salary is a higher rate tax payer, it might work out cheaper to pay a salary. It did last time I did the calculations, but the rates have changed since then.

There are one or two things you can do. Computers is one, mobile phones is another, but they won't make much of a dent in the profits.

On most benefits, yes.

Company cars are taxable, and NIable, and usually best avoided. A car allowance is treated as part of your salary.

Ronald Raygun · Answer

Actually it's 32.75%: (0.30x1500 - 0.19x300) / (1500 - 300) = 0.3275

At the margin it's true. If all the spare profit is paid out as dividends, each marginal pound of gross profit leaves 67.25p after CT available to be paid out as dividends, of which the taxpayer keeps

75%, which is 50.44p. Were the same marginal pound instead paid as salary, 11.35p would go as employer's NI, and of the remaining 88.65p the employee would keep 59%, which is 52.3p. *But* you'd have to go a fair old way past the £300k profit point before the marginal advantage of taking the dosh as salary is enough to outweigh the advantage of not taking dosh below the £300k point as salary. In fact, by my calculations "fair old way" works out as *beyond* the £1500k profit point, at which the marginal position re-reverses. The end effect is that it's never an advantage to take the dosh as salary except for the initial freebie.

One thing that can throw the figures off, though, and clobber this conclusion, is if any of the salary is diverted into pension funds.

Optimal CT/Dividends/Pay split for Ltd. company?

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