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TaxationWeb by Mark McLaughlin ATII TEP

Tax planning for profit extraction from family companies can generate considerable tax savings. This will assume greater significance from 6 April 2003 when NIC rates increase. Mark McLaughlin, Associate with tax specialists Forbes Dawson, considers some of the planning opportunities available.Planning for the extraction of profits from the family company will assume far greater significance when National Insurance rates increase from next year.

In addition to the 1% increase in employee’s NIC from 6 April 2003, further contributions of 1% are payable on earnings above the upper limit. Employers are also faced with a 1% increase in secondary contributions.

Salary v Dividends

Many family companies liable to corporation tax at the small companies’ rate (19% from 1 April 2002) already pay dividends as part of the business owner’s remuneration package, on the basis that there are no NIC’s payable on dividends. Some companies pay substantial dividends with little (or no) salary, as the national minimum wage is not generally relevant to most owner managed businesses.

There will be an even greater onus on such companies to pay dividends instead of salary or bonuses from 6 April 2003. Recent changes to the personal pension rules mean that a dividend policy need not necessarily have an adverse effect on pension contributions, where no company pension scheme exists. Contributions of up to £3,600 per annum (gross) can be paid without any earnings in the tax year.

The ability to pay personal pension contributions above £3,600 per annum depends on the contributor’s age and level of earnings. However, it is possible for an individual’s earnings to form the basis for pension contributions in the same and following 5 years, even if dividends are paid instead of earnings in those subsequent years. The payment of bonuses every 6 years with dividends in the intervening years will allow the individual to make personal pension contributions are a higher level than £3,600 per annum, subject to the individual’s upper earnings limit.

For companies liable to corporation tax at rates above 19%, the choice of salary or dividends becomes less clear cut, and the advice in these situations is therefore to “do the numbers”.

A further option might be to retain profits in the company for use in its trade. It is relatively well known that the effective rate of capital gains tax on business assets upon a sale or winding-up of the company after 2 years is only 10%, where full taper relief is available. Taking into account the effects of corporation tax on profits, the overall effective tax rate for shareholders of small companies (paying tax at 19%) is only 27%.

Further Information

For further details of remuneration planning for owner managed businesses, please call Mark McLaughlin, Associate with tax specialists Forbes Dawson on 0161-245-1090 or by email at mark@forbesdawson.co.uk.