Directors of family companies are able to exercise some control over the timing of payments made to them by the company, and consequently the level of their income in a particular tax year. This can be useful from a tax planning perspective.
Other articles in this series have explored tax-efficient strategies for extracting profits from a company and the pros and cons of extracting profits by way of salary, bonus or dividend. This article examines the impact that the timing of particular payments can have on the director’s tax liability.
From a timing perspective, one needs to consider whether it is beneficial to accelerate a payment so that it falls in an earlier tax year or delay it so that it falls in a later tax year. Playing with the timing of payments around the tax year end may be useful if the rates of income tax, National Insurance or corporation tax are lower in one year than in the other. Moving income between years can also affect the rate at which the director pays tax or preserve entitlement to personal allowances.
Where tax rates change from one year to the next, accelerating or delaying a payment such that it falls in the tax year in which rates are lower will save tax or National Insurance. For example, the rates of Class 1 National Insurance increased by one per cent for both employers and employees from 2010/11 to 2011/12. Consequently, if a bonus payment of £50,000 had been made on 31 March 2011 rather than on, say, 10 April 2011, both the employer and employee would have each paid an additional £500 in National Insurance. Accelerating the payment saved £1,000 in National Insurance.
Further, the small profits rate of corporation tax was 21% for the financial year 2010, falling to 20% for the financial year 2011. Accelerating the payment would have had the added advantage of saving corporation tax at 21% rather than at 20%. Similar considerations apply whenever there are rate changes from one year to the next.
Director’s marginal rate of tax
For 2011/12, income tax is payable at the basic rate of 20% in the first £35,000 of taxable income, at 40% on taxable income between £35,001 and £150,000 and at 50% on taxable income above £150,000. Tax is payable on dividends at a rate of 32.5% for higher rate taxpayers and at 42.5% for additional rate taxpayers. Changing the timing of a payment so that it falls in a particular tax year can affect the rate at which tax is paid.
Ben is the director of his family company. He is considering paying a net dividend of £45,000. Excluding the dividend he has taxable income of £150,000 in 2011/12. He anticipates his taxable income excluding the dividend will be around £50,000 in 2012/13.
A net dividend of £45,000 equates to a gross dividend of £50,000. If the dividend is paid in 2011/12, Ben will pay tax at the additional dividend rate of 42.5%, generating a tax bill of £16,250. By delaying the dividend until 2012/12 in which his income is lower, tax is payable at the higher dividend rate of 32.5%, giving an associated tax bill of £11,250. Delaying the dividend means that it is taxed at a lower marginal rate, saving tax of £5,000.
Care must be taken where income is around £100,000 as this may jeopardise the availability of the personal allowance (see below).
Keeping the personal allowance
The personal allowance (£7,475 for 2011/12) is reduced by £1 for every £2 by which income exceeds £100,000. This means that for 2011/12, the allowance is lost completely once income exceeds £114,950. Further, the effect of the loss of the allowance increases the effective rate of tax between £100,000 and £114,950 to 60 per cent.
Where income for a year is likely to fall in this band, deferring or accelerating bonus or dividend payments so as to reduce income to below £100,000 can preserve entitlement to the personal allowance and save tax at 60%.
The overall tax liability is not just dependent amount paid to the director and the nature of the payment. Timing is also critical.
By Sarah Bradford