Profit extraction: maximising efficiency for this year and the next

Remuneration tactics

As a general rule, for director shareholders a small salary topped up by dividends out of company profits is the way to go for maximum tax efficiency. The salary should be pitched below the level at which NI contributions begin, but at least equal to the NI lower earnings limit (LEL). This is a key target figure for tax efficiency even if the company’s profits have been hit by the pandemic.

Salary, NI and state benefits

When considering how much salary to take there are two limits to watch. The first is the LEL. At a salary equal to at least that point neither the individual nor the company pay NI, but the individual get the NI credits that count towards the state pension and other benefits. The second is the primary earnings threshold (PET), which is the point at which the individual starts paying NI. In between these two limits is the secondary earnings threshold (SET) which is the starting point for the company to pay NI. 

If the individual only has one source of earnings, or isn’t paying NI on other earnings they have, the optimum level of salary to take from the company is between the LEL - which for 2021/22 (and 2020/21) is £6,240 - and the PET - which is £9,568 for 2021/22 (£9,504 for 2020/21).

If the owner manager hasn’t paid themself a salary in 2020/21, or it’s less than the SET, they have until midnight on 5 April 2021 to do so to ensure they get NI credits for the whole year.

Dividends

If the company’s profits have fallen or it’s registered a loss, care needs to be taken when deciding whether and how much to pay in dividends. The owner manager needs to consider both the tax year and the company’s financial year. Remember that a company can only declare and pay  dividends if it has accumulated profits. This means if it has little or no profits, time spent deciding whether to pay dividends or not to maximise tax efficiency is academic as the company must have enough profits to cover the dividend it wants to pay. If its income has fallen off there are increased tax and other risks to paying dividends.

If dividends are paid in excess of a company’s profits, the excess is unlawful, and the shareholders may have to repay some or all of what was received. Until they are repaid HMRC will treat the excess dividends as a loan to the director shareholders which potentially triggers a corporation tax charge.

Profits available

If a company has sufficient accumulated profits to more than cover any losses in the current year, the owner manager can think about how much dividend to pay in addition to their salary in order to achieve maximum efficiency . This can be a tricky balancing act if there are two or more director shareholders whose taxable income differs significantly. Notwithstanding that, the target is to pay a dividend that brings the total taxable income for 2020/21 up to the basic rate threshold of £50,000. Up to this level they’ll only pay 7.5% tax on dividends, taking full advantage of the low tax band, and allowances. Of course, if further funds are needed dividends will be the most tax efficient way of getting them out if there are sufficient profits. At this stage it’s too early to worry about dividend levels for 2021/22.