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Reeves asks; are you tax efficient?

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If you are a shareholding director/employee of a private company, are you tax efficient?

In many small companies the owners are also the directors and this gives considerable scope in deciding how the profits should be extracted. Traditionally, most owners paid themselves salaries as directors and tended to ignore their dual role as shareholders entitled to receive dividends. At Reeves we often note this potential opportunity when discussing remuneration planning with new clients.

Case study – Tax Inefficient Limited
Tax Inefficient Limited is a profitable company run by Joe and Josephine Bloggs and John and Jane Smith as a family business. All four work individuals work in the company. Joe and Jane as the main directors take a salary of £60,000 per annum, whereas Josephine and John take salaries of £20,000 for their duties.

Broadly speaking Joe and Jane pay 20% income tax on their income up to £40,000 and 40% on the balance, in addition to National Insurance Contributions. The company also pays NIC at 13.8% on the salaries over £7,600.

Between the individuals they will pay in the region of £44,000 of income tax and NIC, and the company will pay a further £17,832 in NIC payments.

What is the best way to extract profits?
A profitable company can pay dividends to its shareholders in a more tax efficient manner than paying salaries. Salaries require PAYE to be operated for the deduction of income tax and National Insurance, whereas no tax is deducted at source on the payment of the dividend.

A salary provides the company with a taxable deduction against its profits, whereas a dividend is paid from taxed profits. However this is not as tax inefficient as it may seem, as the company is not required to deduct National Insurance on dividends.

This can also be beneficial to the individual as the rate of tax on dividends is lower than that of salary payments.

A company could also make a contribution to a pension scheme for its employees without creating an income tax or NIC liability.

A new dawn
In light of their advice Tax Inefficient Limited decide to change their approach and decide to take remuneration in the most tax efficient manner by taking small salaries and the balance of their remuneration by way of dividends.

Although the company will pay more corporation tax, roughly £36,000, they will make a saving in NIC payments making a net increase of £18,000. However between the four individuals they will make significant tax savings of almost £42,000. The net tax saving being £24,000.

For most individuals running privately owned companies, the payment of at least part of their remuneration by way of dividends can be more efficient from a tax perspective. It is important not to immediately assume that dividends will always be the most appropriate method.

Should you wish to know more, please do not hesitate to contact Margaret Connolly at Reeves 01227 768231 or email