There are three particular “plans” for tax changes which the government allegedly has in mind, at this most unusual time in UK politics and economics.
- the suggestion that the basic rate band threshold might be increased, from its current level of £50,000, to £80,000;
- the suggestion that the lower limit for all NI purposes might be aligned with the Income Tax personal allowance at £12,500 (another significant potential increase, up from c£8,600 currently for most purposes); and
- the longstanding commitment for the rate of Corporation Tax to drop from 19% to 17% on 1 April 2020.
We must stress that this blog does not, and will never, include any kind of party political message, but we think it is nevertheless interesting to calculate what government ideas (sensible, crackpot, or whatever) could mean for our clients.
Furthermore, we like to see what impact the changes could have on the differential in our company owners’ potential net income, achievable from two alternative extraction policies, ie from:
- extracting their money by (the usually least tax efficient method of) salary; or
- extracting their money by (the most commonly adopted, and generally much more tax efficient, method of) a “threshold” salary plus dividends.
Adopting some reasonable assumptions about other necessary adaptations to the tax rules (for example, making the assumption that the higher Basic Rate Band threshold would also become the new Upper Earnings Limit threshold for National Insurance purposes), we calculate the following results:
Under the current tax rules
|Net cash for the individual from an £80,000 salary||£54,936 (69%)|
|Net cash for the individual from an £8,600 salary and £65,812 divis*||£63,815|
|The annual benefit of a planned extraction policy is therefore||£8,879|
Theoretical future regime
|Net cash for the individual from an £80,000 salary||£58,400 (73%)|
|Net cash for the individual from a £12,500 salary and £63,756 divis*||£71,624|
|The annual benefit of a planned extraction policy is therefore||£13,224|
[*the dividend amount in each case here is that amount which makes sure that the net cost to the company of the two alternative extraction methods, in each scenario outlined, is identical. ie. the company is exactly neutral between £80,000 salary and the proposed threshold salary plus dividends amount, in each scenario. By making the company neutral, the whole of any difference, between the two different extraction policies, accrues in net cash terms to the company owner.]
Results – current regime
We can see that, under current rules, the earner drawing a salary of £80,000 (with no other income), achieves £54,936 cash, representing a net 69% income (or an effective overall tax cost of 31%).
The company owner who replaces an £80,000 salary with a corresponding-cost “threshold” wage plus dividends, achieves £63,815 cash, which is a staggering £8,879 higher, per annum.
Results – theoretical future regime
We can see that, under the theoretical future rules, the earner drawing a salary of £80,000 (with no other income), achieves £58,400 cash, representing a net 73% income (or an effective overall tax cost of 27%).
The company owner who replaces an £80,000 salary with a corresponding-cost “threshold” wage plus dividends, achieves £71,624 cash, which is an even more staggering £13,224 higher, per annum.
So, while the £80,000 salary-earner is potentially made better off, under the suggested tax changes, by £3,464 per annum (ie comparing £58,400 potential future net with £54,936 current net), the company owner who is taking “threshold” wages and dividends from their company sees their net income improve by £7,809 per annum (ie comparing £71,624 potential future net with £63,815 current net).
Improvements for all taxpayers, but a more than double improvement for the company owner over their salary-taking peers!
NB. The principal reason for this significant difference in the level of net cash improvement achieved under the two different extraction methods, comes from the fact that the salary-taker would pay 12% NI on the whole of the £30,000 uplift in their Basic Rate Band. The company owner, meanwhile, would continue to extract their income by the classic method that avoids all NI – and their net cash improvement would not, therefore, be restricted.
The extraction methods outlined above are just two of a potentially wide variety of options, depending upon the taxpayer’s specific circumstances. Nevertheless, the assessment here helps to reinforce a fundamentally important message, which is this;- there can be hugely different net cash outcomes accruing to how an owner extracts their income from the company, and so planning is essential.
Please contact your relationship principal here, or Tax Partner, Chris Barrington, if you are in any doubt about the efficiency of the policy you are adopting and let’s consider whether there might be scope to achieve more.