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Where Taxpayers and Advisers Meet
Time to ditch the dividends?
19/08/2021, by Danny Baker of Bradley Chilvers & Co, Tax Articles - Company Taxation
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Danny Baker, of Bradley Chilvers & Co., champions the cause of company pension contributions as part of a tax-efficient remuneration policy.

Introduction

There are three essential methods to extract profits from a limited company on a recurring basis, being salary, dividends and pension contributions. Do we overlook the pension approach? Advice has continually been to take low salary and dividends, but with the current dividend regime, should we be evaluating that stance?

Over the past 5 or 6 years the government has introduced a number of measures that have eroded the tax advantages for director-shareholders, fundamentally as a result of increasing income tax on dividends. With that in mind dividends remain the preferred option for most directors, as they require that income immediately. However, pension contributions remain the most tax-efficient approach to profit extraction for long term efficiency – subject to investment performance. Persuading directors to seek such means for profit extraction may well be the advice to offer.

Eligibility

Registered pension schemes can accept contributions from the individual and, commonly, from the limited company employer as well. If the plan does not accept employer contributions it is typically not that tricky to change the plan so they can, ask to speak to a financial advisor. A company can make substantial amounts to a pension scheme, up £40,000 in a year (subject to the annual allowance). Also, if the previous three years’ annual allowances have not been fully utilised the company can make a larger contribution to take advantage of any unused annual allowance carried forward.

One factor to consider here is that an employer contribution is not limited to the relevant earnings whereas personal contributions are. Thus, if a low salary is applied i.e. £12,500, then the director/shareholder is personally limited to gross contributions of £12,500 whereas a company employer can continue to contribute towards the full annual allowance of £40,000 (potentially enhanced, as noted above). Also note that high-earning business owners may well see their annual allowance tapered down to just £10,000. Pension contributions have the added advantage that your client’s company can pay them irrespective of whether a loss has been created, whereas this may limit the scope for dividends.

The Tax Relief

Providing contributions are “wholly and exclusively” for the trade, pension contributions are paid gross before receiving a full tax deduction for corporation tax, with no national insurance payable. That currently means a corporation tax deduction of 19% although from April 2023 that is set to rise to 25%. If the client is a basic rate taxpayer, they can finish up with more net income than cash they initially had. They will however have to wait until they are 55 (set to rise to 57 by April 2028), to get hold of that pension income so there is a trade-off between the immediate requirement for the income and the long-term advantages. See below a table to show the benefits with the current corporation tax regime and the one replacing it (assuming the full £2,000 dividend allowance has been used). These figures also assume that the lifetime allowance charge has not been applied.

Other Benefits

There are also additional benefits of depositing money into a pension scheme, such as the tax – efficient growth of the investments. Once invested into a pension the pension grows largely tax free, (although administration fees may be applied), which results in sharper growth than if invested personally. Generally, it can be controlled which investments the client wishes the pension provider to invest in; alternatively the investments can be made on their behalf which has the added benefit of using a pool of experts that may well maximise the capital invested.

See below an illustration showing the potential benefits, assuming the pension fund value remains constant as well as no fund charges applied.

 Corporation Tax at 19%

 

 

Taken as a Dividend

Taken as a Pension Contribution

Gross Profit

10,000.00

10,000.00

Corporation tax Relief

-

1,900.00

25% Pension Relief

-

2,500.00

Taxable

10,000.00

7,500.00

Basic Rate (7.5%/20%)

750.00

1,500.00

Tax relief taken as dividend (£1,900)

-

142.50

Net Income

9,250.00

10,257.50

Higher Rate (32.5%/40%)

3,250.00

3,000.00

Tax relief taken as dividend (£1,900)

-

617.50

Net Income

6,750.00

8,282.50

 

Corporation tax at 25%


 

Taken as a Dividend

Taken as a Pension Contribution

Gross Profit

10,000.00

10,000.00

Corporation tax Relief

-

2,500.00

25% Pension Relief

-

2,500.00

Taxable

10,000.00

7,500.00

Basic Rate (7.5%/20%)

750.00

1,500.00

Tax relief taken as dividend (£2,500)

-

187.50

Net Income

9,250.00

10,812.50

Higher Rate (32.5%/40%)

3,250.00

3,000.00

Tax relief taken as dividend (£2,500)

-

812.50

Net Income

6,750.00

8,687.50


 

 

About The Author

Danny Baker is a tax director of Bradley Chilvers & Co (Accountants) Limited, a boutique firm of chartered tax advisers and accountants. Providing expert technical assistance on all areas of tax on family businesses, their owners, and other wealthy individuals.

109 Knowles Hill
Rolleston on Dove
Burton on Trent
Staffs.
DE13 9DZ

(T) 01283 521421
(F) 01283 8113779

(E) enquiries@bradleychilvers.co.uk

(W) www.bradleychilvers.co.uk

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