Enter Your E-mail

Tax Planning For Family And Owner-Managed Companies by Peter Rayney FCA FTII TEP

Peter Rayney FCA FTII TEP, Author of Tottel’s ‘Tax planning for family and owner-managed companies’, considers some important factors that may influence the level of remuneration paid to working shareholders.

Factors influencing levels of remuneration

Many family or owner-managed companies do not follow any particular remuneration strategy and simply leave matters to market forces. Whilst a rigid set of rules may well be inappropriate, nevertheless proper remuneration planning can be to everyone’ s advantage.

For working shareholders the level of remuneration will generally be determined by a number of factors:

(a) dividend strategies as a means of mitigating the impact of costly NICs;

(b) the need to make a suitable pension provision, although the post-5 April 2006 rules give considerably more flexibility for company pension contributions. Personal pension contributions are still dependent on sufficient remuneration being taken to ‘frank’ the tax relievable contribution;

(c) the anti-avoidance IR 35 rules for taxing income of personal service companies;

(d) the possible commercial need to retain a specific level of profits;

(e) meeting the national minimum wage (NMW) requirements (where there is an underlying employment contract) of £5.05 per hour (from 1 October 2005 – previously £4.85 per hour);

(f) the requirements of a shareholders’ agreement, for example, with a venture capitalist investor;

(g) the possible need to keep directors’ remuneration within the limits imposed by a lending bank; and

(h) the working shareholders’ personal spending requirements.

The interests of non-working shareholders may often be different, but they will be keen to see the adoption of a properly formulated and consistent strategy.

The general staff of the business will have their own agendas too: their first concern will be an appropriate level of basic remuneration, but they will also be interested in fringe benefits and performance-related bonuses.

The Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) consolidates the tax provisions dealing with employment income, benefits, share schemes and pensions.

Current state of play on PAYE and NIC mitigation

Many companies are seeking to minimise the current high levels of NICs. For the working shareholders, this is likely to involve ‘payment’ in the form of dividends (see 2.9 and 2.10) and perhaps the payment of company pension contributions for their benefit. The use of salary sacrifices and tax-efficient benefits may also be useful.

Some small companies have been substituting dividends for bonuses by using so-called ‘alphabet share’ arrangements for their employees. Broadly, these involve issuing employees with A, B, C, etc shares carrying an entitlement to such dividends as may be declared by the ordinary shareholders/directors, but with minimal other rights. However, it is thought that ITEPA 2003, s 447 is likely to apply to tax such dividends as ‘NIC-able’ employment income. However, pro-rata dividends paid on fully-fledged ordinary shares are unlikely to be caught by these rules (even where the shares are employment related). The position is less clear where the employees receive ordinary shares carrying full rights with the shares being designated into different classes to enable different levels of dividend to be paid to particular employees or groups of employees (see ICAEW Tax Faculty Taxline, March 2005).

Employee benefit trusts and the decision in Dextra Accessories

In recent years, employee benefit trusts (EBTs) have also increased in popularity, with many schemes being structured to ‘re-characterise’ payments made to employees without triggering PAYE or NIC liabilities.

However, a severe blow was dealt to the tax efficacy of a large number of EBTs by the House of Lords in MacDonald v Dextra Accessories Ltd [2005] STC 1111. Tax relief for the company’ s contributions to the EBT was denied on the basis that there was a reasonable prospect of the entire funds being paid out by the trust intermediary as employees’ remuneration. This meant that they constituted ‘potential emoluments’ (within what was FA 1989, s 43(11)), thus postponing the tax relief until they were actually paid out to (and taxed on) the employees. HMRC has set up a special team to project manage the collection of tax on a consistent basis for those cases affected by this decision.

The effectiveness of such arrangements was further nullified by the Finance Act 2003, which (from 27 November 2002) broadly defers corporation tax relief for contributions made to EBTs until the relevant amounts have been subjected to PAYE and NIC.

January 2006

Peter Rayney FCA FTII TEP

The above article is extracted from Peter Rayney’s book Tottel’s ‘Tax planning for family and owner-managed companies 2005-06’. For further information and to order this book, click here