Practical guide: profit extraction for 2023/24

Tried and tested

The tax motivation for incorporating a sole trade has reduced significantly, especially where you want to extract all profits from the company. Despite this,there are still many single director shareholder companies where the owners are used to taking a small salary, and the rest of the profits as dividends.

If you want to keep things simple and keep ticking along using this method, you really only need to worry about checking whether the profits are likely to mean you lose your personal allowance (in which case there is no advantage to paying a salary). We’ll assume this isn’t the case here.

For 2023/24, there will be a marginal saving by opting for a salary of £12,570 (the level of the NI primary threshold and personal allowance) rather than £9,100 (the secondary threshold). Let’s suppose there are profits of £60,000 to distribute and no other income to complicate things:

Salary	£9,100	£12,570
Primary Class 1	£0	£0
Secondary Class 1	£0	(£479)
Corporation tax	(£9,739)	(£9,012)
Dividend paid	£41,161	£37,939
Tax on dividend	(£3,211)	(£3,291)
Total tax/NI	£12,815	£12,782

 

Either option is still more efficient than a sole trader with £60,000 profits - saving around £2,500. However, at higher levels of profit the savings are much smaller and eventually it is more tax efficient as a sole trader using this strategy. As an example, with £100,000 profits, the saving reduces to around £1,000.

You may be reluctant to change this tried and tested strategy, but doing so can yield significant savings, particularly where profits are high enough to make you an additional rate taxpayer. Here are some simple ideas:

• bringing in a second family member to share profits with. This is especially useful if this is a spouse or civil partner as multiple allowances and basic rate bands can be used
• restricting the dividends paid to the amount needed rather than aiming for full extraction each year, reducing the income tax charge. The undrawn profits can then be used to smooth fluctuations, e.g. where profits are lower, in later years, or withdrawn efficiently when the company ceases trading, e.g. on retirement
• using some of the undrawn profits to make employer pension contributions. This saves income tax in the same way as the previous point, but also attracts a corporation tax (CT) saving. The downside is that the money is locked away until the pension can be taken
• using undrawn profits to make investments within the company, e.g. investing in shares or property. This may be attractive if the overall aim is to build a nest egg for retirement.

Thinking further - case study

Consier a close company with three director shareholders and annual profits that have grown to regularly fall between £400,000 and £500,000. They want to review possible alternatives to their current remuneration strategy, which is a fixed salary of £50,000 each, aimed to keep them within the basic rate band each year. They make personal pension contributions from their net income. They also use their own cars for company business. The company has built up considerable accumulated profit reserves as a result of this restrictive strategy.

The only profit extraction change that has been considered is swapping some of the salary for dividends. This would increase the efficiency.

Example

The current strategy leaves each director with just over £38,000 after tax and NI. Some of this is then used to make pension contributions and pay for fuel (assume £8,000 in total). Switching to a salary of £12,570 and £37,430 in dividends would increase the net income to over £46,000 (£38,000 after the fuel and pension contributions). Of course, as dividends aren’t deductible for CT purposes, the cost to the company would increase, but there is an overall saving.

However, with some simple planning you can improve on this further.

Business mileage

As each director uses their own car, they can extract money from the company by using the approved mileage rates and claiming for business mileage. Let’s assume each partner does 10,000 qualifying miles each year, meaning they can claim £4,500 tax and NI free. This improves efficiency, as the directors are no longer funding business travel from net pay.

Pension contributions

Currently, the directors are paying personal contributions out of net income. This will attract basic rate tax relief, but there is no relief for the NI paid on the salary used to make the contributions. This could be improved upon by having the company make employer contributions instead.

Let’s say the company will pay £6,000 for each director. After CT relief at 25%, the net cost of this will be £4,500. In contrast, making the equivalent net personal contribution of £4,800 would require a gross salary payment of just over £7,000, with secondary NI of over £900. The net cost after CT relief would be more than £6,000.

This improves on the basic salary and dividends mix because both the mileage payments and pension contributions will be deductible for CT purposes.

The rest of the income required to keep within the basic rate can then be taken as dividends, leaving the remuneration looking like this:

	£	Tax	Net income
Salary	12,570	0	12,570
Dividend	27,000	2,275	24,725
Mileage	4,500	0	4,500
Pension	6,000	0	6,000
TOTAL	50,570	2,275	47,795

 

The result is in-pocket cash of almost £42,000 (the pension is obviously unavailable until it can be accessed) and is a significant improvement over £38,000 in take-home pay, especially when you consider the fuel and pension contribution would reduce that further under the existing strategy.

Further ideas

Going forward, the owners could look at ways to access some of the accumulated profits - particularly if there is a concern that a large cash balance would be a problem for inheritance tax purposes. One suggestion could be making large pension contributions for each director to use up their available annual allowances, and unused allowances from the prior three years. The annual allowance increased to £60,000 for 2023/24, whilst the directors’ relevant earnings are lower than this, employer contributions are not restricted by reference to earnings.

Another idea might be to look at providing the directors with tax-efficient company cars as and when they are looking to replace their vehicles. 

If the directors want to completely extract the accumulated profits, there will be a large income tax bill. However, they could mitigate this by making investments that attract upfront income tax relief, e.g. using the enterprise investment scheme or venture capital trusts.