Cash extraction for business owners

Jeremy Hunt announced in his 2024 Budget further reductions to the main rates of National Insurance for both employees and the self employed.

With effect from 6 January 2024, the main rate for employees was reduced from 12% to 10% and will reduce again to 8% from 6 April 2024. Also effective from the same date, the self employed will see their main rate reduced by 3% to 6%.

2023 also saw an increase in Corporation Tax rates from 19% to 25% for companies with profits over £250,000. Most companies with profits under £50,000 will still be taxed at 19% with a tapered 26.5% rate for profits between £50,000 and £250,000. These limits need to be divided between ‘associated’ companies.

Bearing in mind the 1.25% increase in dividend rates introduced in 2022, how do all these changes impact the decision on how profits are extracted from the family company? Historically, a ‘low salary, high dividend’ strategy produced the best net cash position. Will this still be the case, or going even further, could a partnership/LLP arrangement, which is outside the corporate tax regime, now be more efficient?

The answer, of course, is dependent on the individual’s specific position, however, the effective marginal rates of tax on extraction are shown below. The model here assumes a 25% Corporation Tax rate, to compare the options (the effective rate being for every £100 of taxable profit, the £ tax paid for taking that profit out of the business).

Notably, effective rates of tax for director/shareholders of a company paying 25% Corporation Tax are higher than self-employed rates in all tax bands, in both 2023/24 and 2024/25. Directors drawing a salary only also see a lower effective rate in the higher and additional rate bands, when compared to a director/shareholder drawing dividends.

As effective rates are only the ‘top line’ figures, it is useful to consider the net cash position of three hypothetical individuals at varying business profit levels:

• Individual 1 - Dividend Director takes a salary below the National Insurance thresholds and draws the remaining profit as a dividend.
• Individual 2 - Salary Director takes all available profit as salary.
• Individual 3 - self-employed.

The graph below shows the net cash position of each individual on business profits ranging from nil to £300,000.

As might be expected, given the effective rates above, the self-employed individual is better off at all profit levels, with a noticeable advantage starting to arise at approximately £160,000 profit, and progressively improving from this point. That said the non-tax advantages of operating through a limited liability company remain the significant deciding factor for the form of business adopted.

For the majority who are operating through companies they may be wondering whether to continue taking dividends.  When comparing the two strategies, the lower effective tax rate for the Dividend Director at the basic rate ensures their net cash position stays higher throughout the profit range covered here.  However, this advantage gradually erodes at high income levels and becomes negligible for individual dividend levels approaching £300,000.

Overall, the figures are showing that dividend extraction may no longer be the only tax efficient remuneration strategy, particularly for those with high incomes whose requirements are such that they pay tax in the additional rate bands.

However, we are not forecasting a widescale swich to bonus in preference to dividend. In addition to tax there are a large range of factors to consider when remuneration planning. In particular the timing of tax payments under Self-Assessment as compared to the PAYE system are likely to ensure the continued popularity of dividends as the preferred form of extraction  in the large majority of cases. 

For company owners who have property used by their business, or who have lent money to their company, a sometimes-overlooked method of cash extraction could be for the company to pay a commercial level of rent or interest. Both rent and interest are deductible for Corporation Tax purposes, and as they are not within the charge to National Insurance, this can certainly prove to be a tax efficient option. Care needs to be taken here as there may be other consequences of charging either rent or interest.

Additional considerations include methods of profit sharing within the family, tax on the use of certain vehicles and pension contributions, amongst many other things. Any change of structure or extraction strategy should only be carried out with the benefit of specific professional advice.

For more information on the issues raised in this article or to discuss your circumstances, get in touch with Simon Warne or your usual Crowe contact.