Winter 2015
THE TRICKY BUSINESS OF PROFIT EXTRACTION
towards a client’s basic or higher rate tax band and so may affect the rate of tax paid on dividends received above the allowance.
The recent changes to the taxation of dividends will strengthen the case for business owners using pension contributions to extract profits from their company tax efficiently.
Considerable flexibility is available to shareholder directors when considering tax efficient remuneration strategies. In particular, a common strategy has been to pay salary that is just above the earnings limit required to benefit from certain state benefits and just below the level at which employer and employee National Insurance contributions (NICs) become payable, together with a substantially larger dividend. This type of planning will still provide tax benefits, although at a reduced level due to the effective 7.5% tax increase.
HOW THE NEW DIVIDEND ALLOWANCE WILL OPERATE As a reminder, anyone holding dividends will have a £5,000 tax-free allowance regardless of the level of their non-dividend income. Dividends above this level will be taxed as follows: 7.5% for dividend income within the basic rate band 32.5% for dividend income within the higher rate band 38.1% for dividend income taxable at the additional rate band
WHAT ABOUT SHAREHOLDING DIRECTORS?
Overall this type of planning is still valid, though at a reduced level of benefit. The overall position can be improved by incorporating a company funded pension contribution. WHAT ABOUT PENSION CONTRIBUTIONS?
The new tax rates will apply to the actual dividend received by an investor as there will no longer be any requirement to gross-up the dividend.
Pension contributions mean NI is avoided and they are also a deduction for corporation tax. Furthermore, when benefits are taken, 25% of the fund can be received tax free with the balance taxable as income.
The new dividend allowance won’t reduce total income for tax purposes but it will mean that no tax is due on the first £5,000 of dividend income received. Dividends within the £5,000 allowance will still count
The amount of benefits taken under Flexi-access Drawdown can be controlled. This opens the door to efficient retirement income planning, providing the
opportunity to maximise the use of annual tax allowances with pension and other investment wrappers, and potentially reducing the tax on drawdown income to 20% or even 0%. OTHER CONSIDERATIONS WHEN CHOOSING THE PENSION ROUTE It goes without saying that, when considering a strategy, each individual's own circumstances must be taken into account. What may be right for one person may not be the best fit for another. And it's not just the best tax option that can influence choice. As far as pensions are concerned, the following points may also need to be taken into account. Those who already have significant pension funding and who have pension funds in excess of the Lifetime Allowance, or could exceed it with future growth, will need to take account of the Lifetime Allowance tax charge before deciding on their strategy for extracting profits. Those who do wish to continue funding up to the pension Annual Allowance of £40k pa will need to ensure that they don't access any 'income' under Flexi-access Drawdown, otherwise their Money Purchase Annual Allowance will drop to £10k for good and they'll lose any opportunity for carrying forward unused allowance from earlier years. Taking benefits as a pension contribution instead of salary or dividends could mean that 'high earners' stay below the 'adjusted income' limit of £150k, and so avoid the Annual Allowance being tapered (potentially dropping to only £10k).
The tax benefits for making a pension contribution haven't changed – it's just that the merits of taking dividends will diminish.
Paying a pension contribution before April could hold some advantages; The main rate of Corporation tax is set to fall by 1% in April. So making a contribution in the current accounting period could benefit from higher corporation tax relief. High earning clients who will face a reduction in their Annual Allowance to £10,000 from next April may want to maximise their contributions now. Recent pension input period changes could mean that some clients have additional Annual Allowance available before April. In the meantime there is an opportunity to bring forward dividend payments into the 2015/2016 tax year to achieve tax savings. Clearly any further increase in dividend tax rates or a re-shaping of the NICs regime could alter the position. Contact us If you wish to discuss the content of this brief in more detail please contact Louise Eedy directly on 02920 855 244 or e-mail ifa@thomas-carroll.co.uk Why Thomas Carroll?
We have the honour of being named ‘The Chartered Financial Planners of the Year1 by the Personal Finance Society – the body which grants Chartered status to IFA firms and individuals. Our title demonstrates the excellence, commitment to professionalism, training and development of our people which our clients and professional colleagues have come to expect from us. We have recently been awarded Corporate Financial Planning Firm of the Year2 and Retirement Planning
Firm of the Year3 by Bankhall Group, the UK’s largest distributor of financial services. Authorised and regulated by the Financial Conduct Authority. The Financial Conduct Authority does not regulate taxation and trust advice deposits or advice on debt or State benefits. Tax and legislation are liable to change. This information is based on our current understanding of UK law and HM Revenue & Customs practise and legislation we believe may apply in the future. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.
Awarded by the PFS in 2009 Awarded by Bankhall Group in 2012 &2014 Awarded by Bankhall Group in 2010 &2011