In his 2013 Budget speech, the Chancellor announced that from April 2014 a new employment allowance will potentially cut NIC payments by allowing businesses and charities to offset up to £2,000 against their employer PAYE/NIC liabilities. Full details of the allowance are not yet available, but HMRC have indicated that there will be certain restrictions and anti-avoidance measures aimed at preventing those who are not genuine businesses from gaining an unfair benefit.
In advance of its introduction, small business owners may wish to consider the employment allowance when looking at strategies for profit extraction from the business. For example, a sole trader with no employees may consider incorporation. Sole traders (and also most individual partners in a partnership) are self-employed - if there are no employees in the business, there will be no opportunity to claim the employment allowance. However, as a director or employee of the company, the payment of a salary to the business owner could enable the employment allowance to be claimed. Whether it would be better to pay a lower salary plus dividends in that situation would, of course, require consideration.
A small company director may wish to increase a previously modest salary, which will in turn increase both primary and secondary NIC liabilities. If a business owner intends to increase his salary, perhaps to enable higher pension contributions, the employment allowance will no doubt be seen as a welcome ‘bonus’ in the form of a reduction in the overall NIC liability.
A further circumstance in which the employment allowance might be useful is where an individual has previously received a modest salary, plus benefits in kind. Increasing salary to enable the employment allowance to be claimed may be more attractive from the employer’s perspective than providing benefits, where the employer is liable to Class 1A NIC on those benefits at 13.8%. Of course, this assumes that the employer will be unable to deduct the employment allowance from the Class 1A NIC on benefits under the employment allowance system.
Salary v dividend
A popular remuneration strategy for owners of small companies has been the payment of a low salary, with the balance of the business owner’s income being extracted from the company by way of dividends.
Employee Class 1 NICs are payable once the ‘primary threshold’ (PT) has been reached (£149 per week or £7,755 per annum for 2013/14). However, contributions are treated as paid for state retirement pension purposes where earnings equal or exceed the ‘lower earnings limit’ (LEL) (£109 per week or £5,668 per annum for 2013/14). A credit is available on earnings between the LEL and the PT, which in turn helps establish a state retirement pension contributions record, even though no contributions are actually paid. This means that (using 2013/14 rates), small business owners might consider paying themselves a salary of between £5,668 and £7,755, such that they pay no income tax or NIC on the salary but still receive an NIC credit for state retirement pension purposes. If the salary is on or below £148 per week or £7,696 per annum, there is no secondary Class 1 NIC liability for the employer either. This is potentially a very useful and attractive planning tool. However, it is not yet known whether the employment allowance will affect this strategy in the case of ‘one man band’ companies with no other employees.
Practical Tip :
Although the details of the employment allowance are yet to be finalised, HMRC have indicated that the allowance will not be available to individuals who employ nannies or other domestic workers.