Tax planning - director-shareholders

Recent and upcoming changes could have a significant impact on tax planning for business owners. Some of the headline points to ensure you take into account are:

• Change to corporation tax rate for some companies
• Fall in the Dividend Allowance from 6 April 2023
• Higher rates of income tax on dividends introduced in 2022 set to continue
• Fall in additional / top rate threshold from 6 April 2023.

Corporation tax rise

From 1 April 2023, the main rate of corporation tax rises to 25%. Not every company will pay at this rate, however. Profits exceeding £250,000 will be charged at the main rate, but a small profits rate of 19% applies where profits do not exceed £50,000. Companies with profits under this level, therefore, effectively see no change.

For companies with profits between £50,000 and £250,000, the tax rate is tapered. These companies pay at the main rate reduced by marginal relief: essentially, the tax rate increases from 19% to 25% depending on the level of profits. Limits are adjusted where there are associated companies. HMRC has created an online tool to demonstrate how marginal relief works: this can be accessed on gov.uk, by searching for ‘marginal relief calculator’.

Director-shareholders in companies with higher levels of profits are likely to need to plan for the cash flow implications of higher corporation tax bills.

Changes to the Dividend Allowance

The overall picture is less favourable for the future. The Dividend Allowance is set to fall, while dividend tax rates are at a new high, making the extraction of profits by way of dividend payment more expensive.

Dividends falling within the Dividend Allowance are not taxable, and for 2022/23, the Dividend Allowance is £2,000 per year. From 6 April 2023, however, it falls to £1,000, with a further fall to £500 per year from 6 April 2024. The change is likely to impact more than 3.25 million individuals in 2023/24.

The effect of this change is compounded by the increase in dividend tax rates. From April 2022, rates rose by 1.25 percentage points. They are now 8.75% for dividends falling within the basic rate band; 33.75% for those falling in the higher rate band; and 39.35% where falling in the additional rate band. Though the increase was originally part of the measures around the Health and Social Care Levy, the rates are set to continue - despite the fact that the Health and Social Care Levy has been scrapped.

Impact of changes to the Dividend Allowance

Traditionally, many director-shareholders have relied on a combination of low salary and a significant level of dividend payments to extract profits. There are tax advantages to this approach due to the Dividend Allowance, a low rate of corporation tax, and the fact that dividends do not incur National Insurance contributions (NICs) - a saving both for the employer company and the recipient. These advantages are now being undermined.

Dividends are paid out of retained profits - that is, profits on which corporation tax has already been paid. In future, for companies with profits above £50,000, this will mean profits subject to a higher rate of corporation tax, and thus a reduction in the reservoir available to pay dividends. Plus, as the Dividend Allowance shrinks, there will be a much less significant amount available for extraction free of tax. Although incorporation of a business is about more than just tax advantages, these changes make it prudent to keep reviewing whether a company is the best structure for your business.

Remuneration: last-chance opportunities

An appraisal of remuneration strategy is always beneficial. The best solution for you will depend on your individual circumstances. Given the increasing burden of income tax for Scottish taxpayers, it may even vary depending on where in the UK you are based. However, in every case, the form (bonus as against dividends) and timing of remuneration take on unusual significance for director-shareholders this year, with the potential to impact the overall tax position even more than usual.

Top tip: maximise the timing of your dividend payments

Dividend payment in the 2022/23 tax year gives a last-chance bite at the current higher Dividend Allowance, and the higher additional/top rate threshold. You may want to consider accelerating payment of dividends if there is scope to do so.

The procedures around declaration and payment of dividends are complex and it is important to check that it is done correctly. In times of economic stress, it is also important to be sure that there are profits available for distribution.

Read the next section of our tax planning guide: Basis period reform or return to the main page.