MONTHLY FOCUS: PROFIT EXTRACTION FOR 2023/24
Posted on: 26-02-2024
MONTHLY FOCUS: PROFIT EXTRACTION FOR 2023/24
With the January filing season out of the way, thoughts will soon turn to year-end planning, particularly for close company owner managers. In this Monthly Focus, we look at the position for 2023/24, incorporating changes made – including the NI cut from 6 January 2024.
CHANGES FOR 2023/24
Class 1 NI
2022/23 was a messy year for NI for employees and employers alike. The good news is that the payment thresholds are at least consistent for 2023/24. The primary threshold (PT) for directors is £12,570 – equivalent to the personal income tax allowance (currently frozen until 2028). The secondary threshold (ST) (for employers) is £9,100, and so is unchanged this year.
However, the primary Class 1 NI main rate has changed from 12% to 10% from 6 January 2024.Unlike regular employees, directors are subject to an annual pay period, meaning that they won’t pay primary Class 1 NI until their cumulative earnings exceed the annual PT. Following the rate change, directors will use a blended rate of 11.5%.
It’s possible for a director to elect for an alternative method where the NI is worked out based only on the pay received in a particular period, i.e. similar to the method for regular employees. At the end of the year an adjustment is made to reconcile any over or underpayments (see Chapter 2). The effect of this is to align the contributions with those that would be payable if the standard method of NI was used, and potentially correct over or underpayments.
The rates have also reverted following the scrapping of the Health and Social Care Levy. Primary Class 1 contributions will apply at 11.5% to the extent earnings exceed the PT of £12,570, and 2% above the upper threshold (UT) of £50,270.
For employers, the rate for secondary Class 1 has reverted to 13.8%.
Class 2 and 4
For self-employed individuals, there are two classes of NI that apply. Class 2 is a fixed weekly amount of £3.45 for 2023/24. However, due to the increase in threshold the amount does not need to be paid unless self-employed profits exceed £12,570. Where the profits are below this amount, but exceed £6,725, an effective 0% rate applies, whereby no contribution is due but the individual will be treated as accruing a qualifying year for the purposes of various welfare benefits, including the state retirement pension. Where profits do not exceed £6,725, the individual can opt to make voluntary contributions in order to accrue this entitlement.
Class 4 is a profits-based charge. It will only apply if the individual has self-employed profits exceeding £12,570 in 2023/24. Class 4 NI does not confer any benefit entitlements and is essentially a tax in all but name.
The Autumn Statement in November 2023 also announced that compulsory Class 2 will be scrapped for 2024/25 onward. The main rate of Class 4 will also drop to 8%.
Dividends
Despite the NI rates reverting to their 2021/22 levels, the corresponding increase in dividend rates have been retained. The dividend allowance (really a 0% rate) has been reduced to £1,000 for 2023/24, and will reduce to just £500 from April 2024. The rates are as follows for 2023/24:
- taxable within the dividend allowance – 0%
- taxable within the basic rate – 8.75%
- taxable within the higher rate – 33.75%
- taxable at the additional rate – 39.35%
Dividends within the dividend allowance use up the tax band they fall into.
Other changes affecting profit extraction
From April 2023, the main rate of corporation tax (CT) increased from 19% to 25%, with a return to marginal relief. Affected companies will have less after-tax profit available for distribution.
If you would like any assistance with any of these points.
SALARY AND DIVIDENDS 2023/24
For now, we are only considering extracting profits as salary and/or dividends. Note that when we talk about withdrawing profits from the company, it is easy to assume this will be in cash. This is not necessarily the case. The year-end profits could be represented by cash at the bank, but it is not necessary to pay out cash to withdraw profits. Salary or dividends can also be paid by crediting them to the director’s loan account (DLA). Salary must be credited net of any PAYE tax and NI applicable but, of course, dividends can be credited without any deductions.
Note. For the sake of simplicity, we have assumed that in all our examples the individual is only entitled to the personal allowance, i.e. there are no other reliefs or allowances to be considered. This may not be the case in practice.
Optimal position
It’s important to understand that there is no one right answer, as it will depend on each individual’s circumstances. For example, there will be no merit in a director taking a salary if they have other income exceeding their personal allowance. There will also be differences in strategy in situations where the EA is available, e.g. where two spouses or civil partners are running a business through a company together. Additionally, it’s an easy trap to work on the basis that all available profits have to be taken out of the company each year. Whilst this may be the initial mindset of the director shareholders, it may not be necessary and significant savings can sometimes be made by restricting profit extraction.
In many cases, when a director shareholder asks, “what is the optimum profit extraction strategy?” what they are really looking for is advice on what level to set the salary at. This is particularly true for those looking to extract all the profits, and usually the remaining amounts will be taken as a dividend, either in cash or as a credit to the DLA. So, what’s the story for 2023/24? The answer will depend on whether the director has other income, and if the EA is available.
Single person company and no other income
Example 1 – allowance not available
In this situation, the EA isn’t available. This means that any salary above £9,100 will attract employers’ NI at 13.8%. However, because the salary is deductible for CT purposes there is a saving at the applicable CT rate (between 19% and 25%). In previous years, the benefit of this has usually been overshadowed by employees’ NI, the optimum position for a director with no other income, and that has no entitlement to reliefs or allowances other than the personal allowance, has usually been to restrict the salary to the level of the ST. However, as the PT and ST are now so far apart, we need to reconsider. Let’s look at a simple example of a company with profits of £60,000 where the single director shareholder wants to extract all the profits and is looking to optimise the salary level. There are two obvious options, i.e. a salary equal to:
- the ST, £9,100
- the annual directors’ PT (also the personal allowance), £12,570
If all profits are to be extracted, the total tax and NI in each situation will be as follows:
| Salary | £9,100 | £12,570 |
| Employees’ NI | £0 | £0 |
| Employers’ NI | £0 | (£479) |
| CT payable | (£9,739) | (£9,012) |
| Dividend | £41,161 | £37,939 |
| Income tax | (£3,211) | (£3,291) |
| Total tax/NI | £12,815 | £12,782 |
So, for a single person company where the EA isn’t available, and the personal allowance is available in full, the optimum position will be a salary of £12,570. The saving is a paltry £33 (or just under £3 a month).
Employment allowance is available
Example 2 – allowance available
Let’s suppose the same company has another employee who is paid above the PT during the tax year. The EA will now offset the employers’ NI and the results will be as follows:
| Salary | £9,100 | £12,570 |
| Employees’ NI | £0 | £0 |
| Employers’ NI | £0 | £0 |
| CT payable | (£9,739) | (£9,012) |
| Dividend | £41,161 | £38,418 |
| Income tax | (£3,211) | (£3,453) |
| Total tax/NI | £12,949 | £12,465 |
So, where the EA is available there is a more tangible saving by choosing a salary equal to the personal allowance, being £484.
Director has other income and only entitled to personal allowance
Whether the other income affects the profit extraction salary will depend what the income consists of.
Example 3 – personal allowance only
Let’s assume we are looking at a single director shareholder company with profits of £60,000 where no EA is available. The director has £5,000 of rental profits. Can they save tax by altering their profit extraction strategy?
If they opt for the same mix of salary and dividends as before, their tax calculation will look like this:
| Salary | £12,570 |
| Rental profits | £5,000 |
| Dividends | £37,939 |
| Taxable income | £55,509 |
| Income tax | (£5,704) |
| In-pocket | £49,967 |
However, if they restrict the salary to ensure that the salary and rental profits are covered by the personal allowance, the position is as follows:
| Salary | £7,570 |
| Rental profits | £5,000 |
| Dividends | £42,286 |
| Taxable income | £54,856 |
| Income tax | (£4,759) |
| In-pocket | £50,097 |
That’s £130 better in terms of the in-pocket position just by changing the mix of salary and dividends, and underlines why each director shareholder needs to take more than just the company profits into account when looking at profit extraction planning.
All income
Not all other sources of money will mean an adjustment to the extraction strategy. Capital gains are not subject to income tax and so will have no effect on income planning. However, beware gains on things like investment bonds which are classed as “income gains”.
If the rental income qualified for rent-a-room relief, which means an individual can receive up to £7,500 per year tax free for renting part of their main home, e.g. to a lodger, no adjustment would be needed.
Investment interest can be tax free – up to £6,000 in the right circumstances – owing to two savings allowances; the personal savings allowance which is worth up to £1,000, and the starting rate for savings, which is a 0% band worth up to £5,000 (depending on other income). It’s worth keeping in mind that unless the other income is subject to income tax or affects the use of the personal allowance, it will have no effect on the extraction strategy. So, if income is exempt it can be ignored. This will include things like:
- dividends from venture capital trust investments
- interest and dividends from ISAs where the investment limits have been adhered to
- exempt lump sum payments from pension funds.
Profits much higher
Above a certain level of income the personal allowance of £12,570 is abated. It is reduced by £1 for every £2 your taxable income exceeds £100,000.
Example
John’s taxable income for 2023/24 is £110,000. His personal allowance is abated by £10,000/2 = £5,000, leaving him with £7,570.
Above £125,140, there will be no personal allowance at all. The marginal tax rate where the income falls between £100,000 and £125,140 is 60% if it is subject to the main income tax rates (it will be slightly lower for dividends). This is because tax is payable on income that was previously covered by the lost allowance. It’s effectively 20% on the excess income over £100,000 as the abatement rate is at £1 for every £2 of excess, i.e. only half of the excess is actually subject to additional tax.
Example
In John’s example above, the excess £10,000 means a loss of £5,000 of the personal allowance. This will mean the £5,000 will be subject to tax at 40%, in addition to the £10,000 (which already falls into the higher rate tax band). This gives an effective rate of 60%.
TIP
Our recommendation is to try to avoid falling into this marginal rate at all costs.
If the company profits are such that extracting everything would mean your taxable income is above £100,000, will there be any point in taking a salary? There will be no personal allowance to offset it, and a salary will be subject to higher rates of tax than dividends. Of course, the dividends won’t be deductible for CT purposes, but let’s see what the effect of the increased CT rates is.
Worked illustration
Consider two contrasting profit extraction strategies for a single director company with profits of £250,000. The first (strategy A) assumes that the director chooses to take a salary of £12,570, and the rest of the after-tax profits as dividends. The second (strategy B) assumes that the director receives no salary and takes all of the profits out of the company as dividends. The contrasting positions in the company will be as follows:
| Strategy A | Strategy B | |
| Pre-tax profits | £250,000 | £250,000 |
| Salary | (£12,570) | 0 |
| Employers’ NI | (£479) | 0 |
| Profits chargeable to CT | £236,951 | £250,000 |
| CT payable | (£59,042) | (£62,500) |
| Available as a dividend | £177,909 | £187,500 |
The two contrasting personal tax calculations will then be as follows:
| Strategy A | Strategy B | |
| Salary | £12,570 | 0 |
| Dividend | £177,909 | £187,500 |
| Total | £190,479 | £187,500 |
| Tax on salary at 20% (£12,570 x 20%) | (£2,514) | 0 |
| Tax at dividend basic rate | (£2,111) | (£3,211) |
| Tax at higher dividend rate | (£29,511) | (£29,511) |
| Tax at additional dividend rate | (£25,711) | (£24,539) |
| Income after tax | £130,632 | £130,239 |
So, strategy B is the better option, albeit only by a modest amount.
An awkward position will arise if the company profits are at a level where a full withdrawal would mean your taxable income would fall into the abatement range, i.e. between £100,000 and £125,140. The optimum salary level here would be restricted to the remaining personal allowance, with the remainder taken as dividends. The problem is you need to know what the remaining personal allowance is in order to set the salary level. To work out the personal allowance, you need to know the total taxable income, which means you need to know the salary level to work out the optimum salary level – so you’re back where you started.
It may be possible to set up a complex spreadsheet to work this out, or to plot a graph to help approximate the best position. However, this is a lot of work for a relatively small amount of savings. There are far easier ways of maintaining efficiency here, and we will look at these in the next section.
Undrawn profits
Remember, you could pay the equivalent of 60% tax on up to £25,140 of income where your taxable income falls between £100,000 and £125,140. Leaving profits undrawn is one way of avoiding this.
This stems from the fact that when you draw profits as a dividend, it is effectively taxed twice – once in the hands of the company as profits, and once in your hands as dividend income. Because you can control the timing of dividends, you can spread the tax bill across a number of tax years. This can be sensible in any case, as it provides a safety net for future years in case of unforeseen events that could adversely affect profits, such as the pandemic.
Example 1
Lilith operates her business through a company and has always extracted all profits using a mix of a low salary and topping up with dividends. In 2023/24, there is a particularly good year, and her profits have increased to £140,000 (they are usually between £110,000 and £120,000). If she adopts her usual strategy and sets the salary at £12,570, the position with full extraction would be as follows:
Company
| Pre-tax profits | £140,000 |
| Salary | (£12,570) |
| Employers’ NI | (£479) |
| Profits chargeable to CT | £126,951 |
| CT payable | (£29,892) |
| Available as a dividend | £97,059 |
Lilith
| Salary | £12,570 |
| Dividend | £97,059 |
| Total | £109,629 |
| Personal allowance | £7,756 |
| Tax on salary | (£963) |
| Tax at dividend basic rate | (£2,790) |
| Tax at higher dividend rate | (£21,659) |
| Income after tax | £84,217 |
Here, there are no profits left in the company. However, if Lilith were to restrict the dividend to just enough to make her total income £100,000, there would be £9,629 in undrawn profits. Her personal position would be:
| Salary | £12,570 |
| Dividend | £87,430 |
| Total | £100,000 |
| Personal allowance | £12,570 |
| Tax on salary | £0 |
| Tax at dividend basic rate | (£3,211) |
| Tax at higher dividend rate | (£16,784) |
| Income after tax | £80,005 |
Her after-tax income reduces by £4,212. Now, let’s suppose 2024/25 is a particularly bad year for the company, and after applying her strategy Lilith has taxable income of £80,000. She can now extract the undrawn profits from the previous year. These will be taxed at 33.75%, leaving her with an extra £6,379 in after-tax income. Delaying taking the profits has therefore saved her £6,379 – £4,212 = £2,167 over the course of the two years. This is because spreading the profits means the personal allowance is no longer abated.
Depending on what the long-term plans are, a director could leave undrawn profits in the company for many years, accumulating a fund that can help boost retirement income, when the dividends are likely to be lower.
Example 2
Let’s assume that Lilith has similar results for another 14 years. She adopts a profit extraction strategy to ensure she doesn’t fall into the personal allowance abatement range, i.e. restricting the combined salary and dividends to £100,000, leaving around £9,500 of undrawn profit in each of those years. Lilith then retires upon attaining state retirement pension age. She receives £11,000 per year initially. She also has a private annuity paying an additional £21,000. Assuming the personal allowance and basic rate band remains the same, these amounts would leave scope to withdraw £18,270 of the undrawn company profits as a dividend, but let’s suppose she needs only £5,000 of this each year. Again, assuming the dividend tax rates don’t change, these will only be subject to tax at 8.75%. The accumulated profits, ignoring any interest or income from company investments using the funds, would be just short of £135,000 – enough to adopt this strategy for almost 27 more years.
Of course, the undrawn profits could be invested by the company to generate capital growth, meaning that Lilith’s company piggy bank could be considerably fatter by the time she reaches retirement. There are also other things she could do with the undrawn profits.
If you would like any assistance with any of these points.
IMPROVING EFFICIENCY FURTHER
Other options
There are more ways to extract value from your company than simply paying out salary or dividends. It’s possible for the company to pay for things that would otherwise need to be paid from your after-tax income. This will usually be a taxable benefit in kind, but there are some benefits that enjoy exemptions, and can be paid with no tax or NI consequences.
Where not all the profits are extracted you could consider having the company make employer pension contributions. This is a very efficient way of utilising excess profits. There are also tax breaks you can take advantage of if your company owes you money by using the two savings income allowances. You can also consider bringing in a second director shareholder, usually a spouse or civil partner. You could do a combination of all these things.
Tax free benefits
Certain benefits, or payments from the company, are tax free, subject to conditions. Three that you should research are mobile phones, mileage payments and trivial benefits.
Phones
No tax or NI is payable where a company provides an employee, including a director, with one mobile for personal use. However, the exemption doesn’t apply unless the contract for the phone is between the company and the phone company; you must not own the phone personally or be liable for the contractual payments. With the latest phones easily costing four figures over the course of the contract, this could be a valuable perk.
Beware that if the company pays the bill for a personally owned phone, i.e. direct to the phone company, the amount paid is taxable as a benefit in kind and must be declared on the P11D. The amount paid counts as earnings for NI purposes and is liable to Class 1 employees’ and employers’ contributions. Note that this does not include any part of the bill that counts as an exempt job expense, which in HMRC’s view is limited to business-related expenses for which there’s an actual cost, i.e. not included in any monthly allowance. Equally, if the company reimburses your mobile phone costs, the amount reimbursed is taxable, not as a benefit but as pay on which PAYE tax and Class 1 NI applies.
Mileage payments
One thing small company owners often overlook is where business mileage is undertaken in your own personal vehicle. The company can reimburse you at 45p per mile for the first 10,000 miles and 25p per mile thereafter for each tax year. The payments are deductible for corporation tax (CT) purposes but are not taxable on you. You should keep detailed mileage logs to back up the payments. The rate that can be paid NI free is 45p per mile for all mileage, even that in excess of 10,000.
Motorcycles and bicycles have their own approved rates – 24p and 20p per mile respectively.
Trivial benefits
Since 6 April 2016 a benefit provided to employees (including directors) that costs an employer no more than £50 is exempt from tax and NI. Subject to the conditions explained below, the tax and NI exemption can apply to as many perks as you choose to get your company to provide you with. If a perk is already exempt, for example, the Christmas party, that exemption takes precedence over the trivial benefits exemption.
Aside from the £50 limit, the perk must not be:
- in cash or a voucher convertible into cash. A gift voucher, for example a voucher to spend in a shop is fine because it can only be exchanged for goods or services and not cash
- a reward for an employee doing their job
- provided as a contractual right of the employment
- provided as part of an optional remuneration arrangement, e.g. salary sacrifice.
As an anti-avoidance measure there’s an additional monetary cap for trivial benefits provided to directors of close companies and their families. As well as the £50 per benefit, the total cost to the company must not exceed £300 per tax year.
Employer pension contributions
If you do not need to extract all of the profits from the company, the excess can be left to accumulate, as in the example of Lilith. Recall that she had just over £15,000 in undrawn profits in each year in that scenario. However, a very powerful planning option would be to use these profits to make employer pension contributions. This is more efficient than letting them accumulate, as the contributions will be deductible for CT purposes. In Lilith’s case, this would save at least £15,320 x 19% = £2,920 (and possibly more if the marginal CT rate is higher) in CT without reducing her in-pocket position.
The obvious downside to this is that the money cannot be accessed until at least age 55 (rising to 57 from 2028) so it is not available for sudden emergencies, or to get you through years with smaller profit levels. It may therefore make sense to retain at least some of the undrawn profits in the company.
Savings allowances
There are two savings allowances which are often overlooked when it comes to profit extraction. The first is the savings starter rate (SSR). The SSR is a nil rate band of up to £5,000 for savings income (such as interest). However, exactly how much is available depends on the amount of your non-savings income. If this is above the personal allowance, the excess is deducted from the available SSR until it is reduced to nothing. Dividends are not taken into account, which is good news if your only non-savings income is a salary of no more than £12,570, as the full £5,000 SSR will be available to you.
The second is the personal savings allowance (PSA). This is available to basic and higher rate taxpayers only and is set at £1,000 or £500 respectively. In determining whether you are a basic or higher rate taxpayer for the purposes of the PSA, you must add together all your income, including all the savings and dividend income, ignoring the allowances.
If you could arrange for your company to pay you some interest, up to £6,000 of it can be received tax free. However, to do this the company must owe you money. This could be in the form of a loan, your DLA having a credit balance, or money owed for assets transferred to the company.
A major advantage an interest payment has over a dividend is that it should be deductible for CT purposes, provided it doesn’t exceed a commercial rate. This is where you will need to do a bit of research but remember that your small company would be seen as risky by a prospective lender, and so getting some quotes for loans to compare interest rates is a good idea. For example, you may find that charging the company 10% on a loan of £60,000 is perfectly acceptable.
Where the loan is likely to be outstanding for more than one year, the company will usually need to deduct tax at the basic rate and report and pay it to HMRC via Form CT61 (quarterly). However, this deduction will then be credited in the personal tax calculation.
Spouse or civil partner as second shareholder
Bringing in a second director shareholder means you have two opportunities to take advantage of personal allowances, basic rate bands, savings allowances and dividend allowances. You can also make pension contributions for them, and the presence of a second person will likely mean that the employment allowance is available. You’re effectively doubling your potential efficiency. It makes most sense for this second person to be a spouse or civil partner for two reasons.
Firstly, you can transfer shares to them with no capital gains tax consequences. Secondly, the money then stays within the family unit, particularly if you manage your finances jointly.
Example
To see what effect this could have, let’s assume Lilith from our earlier examples is having an ordinary year with profits of £100,000. On her own, a full distribution using a salary of £12,570 and the remainder as dividends would leave her with £66,907 after tax and NI. However, if Lilith introduced her civil partner Eve as a director shareholder for 2023/24, then assuming they both take a salary of £12,570, and share the dividends equally (£29,386 each), the position will be as follows:
| Gross profit | £100,000 |
| Salaries taken | (£25,140) |
| Employers’ NI | £0 |
| Profits chargeable to CT | £74,860 |
| CT | (£16,088) |
| Dividends available (total) | £58,772 |
| Income tax | (£4,968) |
| Employees’ NI | £0 |
| After-tax position | £78,944 |
That is a saving of over £12,000!
If you would like any assistance with any of these points.