Tax efficient remuneration planning
A number of property developers and construction businesses are structured either as private or public limited companies whose profits are subject to UK corporation tax at 19%. Described below are some strategies to enable shareholders and key directors to extract cash from the business tax-efficiently. Different permutations of the various strategies will likely be used based on the specific needs of the business and its key stakeholders.
The traditional starting point will be a choice between salary and dividend, or a combination of both. A salary enables you to build up qualifying years towards your state pension, make higher pension contributions, make it easier to obtain a mortgage and provide a degree of certainty even if the business does not make a profit. Nevertheless, it attracts a higher income tax charge (than a dividend) and depending on the age of the employee both the employer and the employee have to pay the National Insurance Contributions (NIC’s). A salary (and associated employer’s NIC’s) however is a tax-deductible expense for the business provided it is ‘wholly and exclusively’ for the purpose of the trade.
Pension contributions can be an important component of the overall remuneration package. The contributions will be limited by an annual allowance (although you can ‘mop up’ annual allowances from the previous 4 tax years) and the Lifetime Allowance (which currently stands at £1,073,100 for most people). The level of tax relief that one obtains will be further restricted by ‘relevant earnings’ which in the main is comprised of salaries and profits from a trade (and excludes dividend or investment income). Therefore, a salary of some sort can enable you to receive income tax relief on the pension contribution. Company pension contributions are also a deductible expense for corporation tax purposes subject to the ‘wholly or mainly’ test.
Key directors who are not shareholders of the business will be restricted to a salary and other benefits such as pension contributions. However, those who are director shareholders will often receive a combination of both salary and dividends to have the benefits of both types of income.
A dividend is simply a share of the company’s profits after it has settled its tax liabilities. It can only be declared from the retained profits, and therefore if the retained profit has been exhausted due to excessive dividends in some years or a downturn in business, then the company may not be able to declare further dividends. Pure reliance on dividend income can bring uncertainty for the owner-managers especially if developers run trading losses like in the present COVID-19 pandemic. Whilst a dividend is paid out of the after-taxed-profits of the business (and therefore it is not a tax-deductible expense), the income tax rates on dividends are generally lower than a salary.
Key employees/directors can be incentivised by offering them an opportunity to participate in the equity of the company. An EMI share option scheme, for example, enables key employees to obtain value in the form of capital gains which can attract Business Asset Disposal Relief (formally Entrepreneurs’ Relief) and therefore be taxed at 10%. This helps align the key employees’ interests with that of the business.
The appropriate combination of the above strategies must be considered in light of the needs of the business and its stakeholders. Careful planning can help you achieve the optimal outcome with a minimal tax charge.
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