Small family companies will nearly always agree a salary to family members within the personal allowance (PA) with dividends on top. If the salary is commensurate with duties performed and made for the purposes of the business, a corporation tax deduction can be taken without creating a corresponding income tax liability. Where both spouses are directors of the company a personal allowance salary should be easily justified.
Some care must be taken as to not trigger an NIC charge for either the company or the employee as the primary earnings threshold for NIC is lower than the PA (the earnings threshold for 2018/19 is £8,424). A payment of earnings between the lower earnings limit of
£6,032 and £8,424 will therefore avoid an NIC charge while also creating an entitlement to retirement benefits (as earnings in this band will count toward the employee’s contribution record).
If the £3,000 employer’s national insurance allowance is available, it would be advantageous to have a salary of £11,850 pa. A small amount of employee’s national insurance at 12% will be due BUT the corporation tax relief of 19% on the additional salary will be greater. The employer’s national insurance allowance will be available unless there is only one individual creating an employer’s national insurance liability and that individual is a director. Husband and wife companies will therefore be entitled to the employer’s allowance where both their salaries exceed £8,424.
Regular dividends can be paid to supplement the owner managers salaries. As long as the paperwork supports the fact that dividends are being paid (minutes and dividend vouchers) then there is little chance of regular dividends being reclassified as salary.
With an increasing move to digitalisation the practice of low salary, high dividend will become even stronger. All businesses should have more timely information available to them and this is key to a low salary, high dividend extraction route.
Example 1 – Client with software
Mr and Mrs Smith each own 50% of their consultancy company SMITHY Limited. They are both directors of the company and each draw a monthly salary of £987.50. Mr Smith works full time in the business and Mrs Smith works around 3 days per week. There are no other employees in the company.
The employers NIC holiday of £3,000 pa ensures that no employers NIC is paid on their salaries.
They each pay employees national insurance of £376pa through the PAYE system of SMITHY Limited. They appreciate that a salary of £705 per month would secure the same state pension and avoid any employee’s national insurance but the corporation tax relief on a salary of £11,850 rather than £8,460 is worth an extra £644. This exceeds their employee national insurance bill, so a personal allowance salary is their chosen remuneration level.
Mr Smith is the main client contact within SMITHY Limited whilst Mrs Smith provides the administrative support. Mr and Mrs Smith do not have formal employment contracts with the company, so the company will not be bound to pay the national minimum wage to either of them. This would be important for Mr Smith who could easily work in excess of 40 hours a week.
Mrs Smith’s salary might be considered high for three days per week, but it should be justifiable give that she is a director of the company. Mr and Mrs Smith often discuss key contracts, direction of the company etc. A salary of £11,850 is perfectly reasonable for the role Mrs Smith performs.
Mrs Smith keeps SMITHYs records on Xero and as such their monthly numbers are available within a week of the month end.
Every month Mr and Mrs Smith look at their results for the previous month and pay dividends based on what they feel is affordable. They consider the monthly profit, the retained reserves in the Balance Sheet and most importantly the available cash.
As their accountants we would draft pro forma minutes that Mr and Mrs Smith complete for each monthly dividend. A Dividend voucher is prepared at the end of the year.
Mrs Smith posts the dividends drawn to dividends in the Xero software.
Their mix of salary and dividends is a sound method of tax efficient extraction and HMRC will have no grounds to challenge their extraction method.
Example 2 – Client without software!
Assume you have a small limited company with minimal retained reserves – essentially a make and take company i.e. whatever they make they extract…
You want a director/shareholder salary of £11,850pa with balance as monthly dividends – but you only know their numbers when your accountants prepare the annual accounts.
How could you ensure that the monthly dividends are “legal”? Given the recent Court of Appeal decision in Global Corporate Limited v Hale we must be sure to avoid the possibility of illegal dividends.
- Post the monthly draws to directors’ loan account. When the numbers are available the accountants prepare paperwork for an interim (or final) dividend to clear loan account.
- Problem with this is you only have one dividend date, so you may have abnormal dividends in a particular tax year.
- And if the loan ever exceeds £10,000 during the tax year you have a beneficial loan interest charge whilst the loan is outstanding. If numbers were available quarterly, then the £10,000 balance may not be exceeded as the loan account is being cleared once a quarter. So monthly draws of £3,000 cleared by a quarterly dividend of £9,000 would avoid a loan interest benefit.
- Prepare monthly dividend minutes but make specific mention that the levels of profit have been considered. Something like “The directors have considered the levels of cash, debtors and creditors at this point in time and consider a dividend of £10,000 justifiable”.
If you have strong retained Balance sheet reserves, it does not matter whether you have timely information available as the retained reserves can cover the dividend draws.
 Reproduced from Tolleys