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Director/shareholder reward packages: The dynamics have changed

Introduction

The introduction of the Employment Allowance (“EA”) allows employers a discount of up to £2,000 off their liability to Employers’ NIC. This has added another factor into the salary vs dividend debate.

There is one other complicating factor as well. The level of other taxable, non-dividend, income enjoyed by the director/shareholder.

If there’s no other income

A salary equivalent to the director’s personal allowance is most efficient. The additional NIC paid by the director (at 12% on the excess over £8,060) is more than compensated by the additional corporation tax saving at 20%.

With no other employees, this works for companies with up to 5 directors/ shareholders.

What if the director has other income?

Many directors own the company premises, and enjoy a rent from that. Where rent (or indeed any other taxable income) is enjoyed by the director, a little more care is needed. The optimal position would be to create total taxable income (excluding dividends) of exactly £10,600 (for 2015/16). So if the director was receiving rent of £3,000 a year, the ideal salary would be £7,600.

What about pensions?

There are two aspects to this.

Contributions to a private pension scheme
Dividends do not count as pensionable income, and so tax relief on personal contributions would be limited to the amount of taxable salary. (Rent doesn’t count either).

The simplest way around this is to get the company to make an employer contribution, but you may need a different kind of pension scheme, and this may need to be negotiated/agreed with fellow directors.

I had just such a case where one of three directors wanted to top up his pension. Unfortunately, the wider savings from the low salary route meant his tax relief was limited to just £5,000, as he already had two smaller schemes running, and the company did not have sufficient profits to get full tax relief on even that small amount.

State pension entitlement
Employees are credited with a year’s worth of contributions if their weekly earnings exceed £112.00 (2015/16 rates). Therefore, the director will need a salary of at least £5,824 to add another year to their state pension accrual. In the example above, a salary of £7,000 meets the criteria, but what if the rental income was £6,000?

Voting a salary of £5,824 would take the director into income tax, as total income would exceed the personal allowance.

At 2015/16 rates, this would impose an income tax bill of £244.80 on the director, but would add a year to the pension entitlement. The cost-benefit decision is personal to each individual; is an extra year’s pension worth paying that tax?

The factors to consider are:

  • how many years before you can take your pension,
  • how long you think you’ll be around to enjoy it, and
  • how much more could you generate in income by saving that tax over the years before you retire/

among others.

Creating alternative income

If the circumstances allow, it may be more efficient to draw one’s income as rent or interest from your own company, rather than by way of salary.

Rent

Any rent charged must be at a market rate. We would suggest that a written agreement is drawn up, making it clear who is responsible for repairs etc., as well as covering the amount of the rent.

Interest

A director can only charge interest to his company if he has a loan account in credit, and there is an obligation on the company to pay interest. Any “interest” paid on a loan which was intended to be interest-free could be challenged and treated as remuneration. In order to avoid any uncertainty, we would suggest a written agreement, which makes clear the terms of the loan. The agreement does not need to be onerous, but a clear statement can help to avoid later disputes.

Action

The start of a new tax year is a good time to review your financial position, as many rates and allowances change. Thankfully, for directors’ salaries, the annual earnings period means you haven’t lost out if your review has not yet been completed.

Contact your adviser, or drop us a line if you’d like a review done of your personal situation.

Numbers (UK) Limited

5 May 2015

Work ON, not IN!

[Originally a guest post on www.owenjonesdesign.com]

 Introduction

It is a real problem when you are doing something you love isn’t it?

You set up your business because you are good at something, or you are passionate about it, or both, but you never seem to make progress. You are busy doing what you love, but somehow it’s not as rewarding as you’d thought it would be.

Very often, that is because you are working IN, and not ON your business.

What’s the difference?

If you are going to reap the rewards of your hard work, then you’ll need to balance these two aspects. Before you can do that, you need to understand what they are.

Working in the business

This is basically doing the stuff for clients/customers that the business was set up to do. For Owen, this is producing high quality design ideas, and implementing them as part of the branding strategy. It involves meeting with the clients, getting to understand both what the client does, and the ethos underpinning that work. Similarly, we follow the same process of understanding the client and their objectives, whether we are preparing a succession plan and managing the process, preparing an Inheritance Tax planning report or discussing a business issue with a client as part of our PMI program (“The Numbers”).

Working on the business is different

This aspect makes the business, or more accurately its owner, the client. It may seem odd, but businesses are merely means to achieve the ends of their owners. If not, the owners become employees of their business, and will often earn more, with less stress, by finding employment with someone else!

Working ON the business involves taking a step away from the day-to-day tasks, and asking yourself strategic questions, like:

What things are important to me?

What does my life need to look like in five years’ time if I can count them a success?

What kind of work/clients do I want for my business?

What things do I need to change to get to those goals?

So, if it’s so important, why doesn’t it get done?

There are several reasons why not, and each requires a different remedy. Here’s a few ideas to get started. (But contact Owen and give him your own ideas!)

1.   The tyranny of the urgent.

So, you have a client deadline fast approaching, and it’s not going too well. The client is demanding a proposal/finished product/sample/presentation…….. and you’re running out of time. This happens to us all, but if you find it happens more than three times a year, ask yourself these questions.

  •  Am I overpromising?

Most clients will be relaxed about an extended deadline if they know about it early enough. Estimate a completion date, and then add an extra week/fortnight to give yourself time to do a quality job.

  •  Is this client worth busting a gut for?

If they are always hassling you, slow in responding, and unreasonable in demanding late changes to your brief, then the answer may well be “no”.

  •  Is the fee worthwhile?

Remember, a large fee is not always a good thing. Think about the time commitment, (including the initial marketing time) and work out an effective hourly rate. You will earn more by taking on two smaller jobs with a higher effective rate.

2.  It can wait.

Of course, long term planning is exactly that, long term, but what will you say in five years’ time? Can it still wait? There’s an old Chinese proverb that states “The best time to plant a tree was twenty years ago; the second best time is now.”

The problem is, every year you delay it puts you back another year in achieving your goals.

3. It’s not what I set up my business to do.

This goes back to my introduction. We get excited about the work the business does, and most of us do not run strategic planning businesses. Therefore, it doesn’t give us that same “buzz” as a well-executed project.

How to make it happen

  1. Schedule your “blue sky” thinking time.

I have a fixed Friday morning appointment in my diary. This 3 hour slot is split between working ON my business, and doing a specific marketing task, such as recording a video for our YouTube channel, or writing a blog. (That doesn’t mean that I don’t do marketing at any other time of the week).

Studies have shown that scheduling a task makes it 20 times more likely to happen. It is much easier to say to a client that you have a commitment if it’s in your diary, than being caught unprepared when the phone rings.

2.  Appoint a business coach or financially literate outsider to work with you.

In this way, you have an accountability partner, and you will make more effort to avoid letting them down. You are far more likely to get out of bed and go for that morning run, if you are meeting a friend, than if you plan to go alone.

A good business coach will earn you far more than their cost, by helping you achieve your goals.

3.  Tell as many people as you can that you are going to do this.

While you are not as accountable under idea 2 above, it is very embarrassing to tell a lot of people that you haven’t done what you promised yourself you would do!

4.  If you cannot afford a business coach, find a fellow business owner, (not a competitor), with whom you can share ideas, problems and your thoughts.

Again, scheduling a regular meeting will benefit both of you. You’ll be surprised how clearly you see solutions to problems that are not your own. Conclusion

Working ON your business is crucial to achieving your goals, but it is not easy to create the sense of urgency or the time to do it. Finding people to help is almost as essential.

If you’d like further advice or ideas, or want Owen or I to help you achieve your goals, get in touch. We’d be delighted to help.

How do I pay a dividend?

Introduction

Director/shareholders of privately owned companies have long been able to reduce their tax and NIC bills by adopting a remuneration structure consisting of a low salary, topped up with dividend payments.

The attraction

A typical family company might make £50,000 a year in profits. At this level, the combined income tax and NIC bill would exceed £13,300. Running the business as a limited company would cut the tax on business profits to less than £8,500. The saving of over £4,800 could be used to enhance the living standards of the owner’s family, reduce the length of their working week, or provide funds for investment in the business.

So what has changed?

On 13 April 2013, HMRC announced that PA Holdings had abandoned its appeal in a complex tax avoidance case, involving the payment of dividends. It also announced that there was no change in policy towards OMBs and their dividend planning.

So that sounds OK but…..

They can still challenge dividends and treat them as remuneration if they are not voted properly.

The legal background

Dividends can only be voted from distributable reserves. These are measured using the accounting rules. It can be a particular problem in the first year of a business, if no accounts have been drawn up. How can you prove that profits have been earned before you have accounts?

Many of our clients employ us, or other bookkeepers, to keep them up to date. In this case, it is easy to prepare a simple, interim, statement, to show an up to date profit position. In fact, if the previous accounts show insufficient profits accumulated, it is ESSENTIAL to have management accounts drawn up, before a dividend is voted.

If the dividend is deemed illegal, the shareholders can be forced to repay it, and HMRC can treat the payment as a loan on which notional corporation tax (the S455 Liability) and income tax (on a beneficial loan) may be levied.

Interim vs final dividends

Most companies now pay interim dividends, which are proposed by the directors without reference to their shareholders. In private companies, there tend to be the same people, so it isn’t an issue, but it is not always the case. Interim dividends are taxed when they are paid. “Payment” in this case can mean being credited to the directors loan account, transferred to an account as requested by the director/shareholder or otherwise made available to spend (by paying down a personal credit card bill for example).

Final dividends can only be authorised by the shareholders in general meeting. They cannot approve more than is recommended by the directors (who have a duty to ensure that the company is managed prudently and in the interests of various stakeholders). As most private companies no longer hold AGMs, it is increasingly rare for final dividends to be voted. The main implication is that dividends are taxed on the date it is declared, unless a later date is specified on the resolution.

General practice

Most reward payments run on a monthly cycle, so you would expect dividends to reflect that. However, it is not always practical, or cost effective, for businesses to prepare the necessary financial reports, and hold a Board meeting to approve dividend payments on such a regular basis. In this case, dividends are usually paid, and later formalised after the company’s year end.

HMRC’s guidance

HMRC state (at EIM 42280) that, a payment cannot be earnings if there is an obligation to repay it. Furthermore, they state they “in the absence of specific evidence to the contrary, the amounts drawn do not actually belong to the director.” Problems can still arise where the later credit to the DLA is a mixed bag of dividend and/or salary/fees/bonus.

So what should we do?

Do check your Articles of Association to ensure interim (or any) dividends are allowable.

Do ensure that each dividend is properly supported with Board Minutes, vouchers and an appropriate resolution.

As far as possible, make sure you actually pay the dividend by bank transfer, rather than credit to the DLA, as this makes the payment date clear. If necessary, the cash can be reintroduced later.

Avoid dividend waivers, as thee are easily attacked under tax avoidance case law.

Remember, dividends can also be paid by the transfer of assets (“in specie” is the legal term), if cash is not readily available.

Conclusion

A low salary/ dividend top up reward package is still available for owner managers who are not subject to national minimum wage legislation. However, care is still needed to ensure dividends are properly paid and documented. Contact your adviser, or us, if you are unsure you comply. Don’t make yourself an easy target by getting the basics wrong.