Corporation tax increase – how does it affect remuneration planning?

From 1 April 2023, corporation tax rates increased from the current level of 19%, also resulting in the return of the small profit rate and main rate of corporation tax.

In turn, this has changed the way that we look at remuneration planning. For many years now, there has been a “rule of thumb” that dividends are generally a more tax efficient way for owner-managers to extract funds from their company. However, with the increase in corporation and income tax rates, a reversion back to salaries and bonuses can, in some cases, now be a more efficient way to extract monies from a Limited company, as they can benefit from corporation tax relief on the salary, whereas dividends are paid after tax.

Frankie Coombe, Tax Senior at BHP, takes a look at the new corporation tax rates and when it might be better for owner-managers to consider a swap from dividends to salary.

Who will the CT increase impact?

For several years now, the corporation tax rate has been unified at 19% for all companies, regardless of profit levels. However, from the 1 April 2023, the main rate of corporation tax increased to 25% where a company has profits over £250,000.

For companies with profits below £50,000, the corporation tax rate remains at 19%.

When profits are between £50,000 and £250,000, there is a gradual increase towards taxing all profits at 25% once the £250,000 limit is breached. Within this ‘marginal’ band, there is therefore an effective corporation tax rate of 26.5%.

The lower and upper limits are proportionately reduced for short accounting periods and where there are associated companies (see below). For example, if a company has one other associated company, the limits will be reduced to £25,000 and £125,000 respectively.

Associated companies

The ‘associated company’ rules, which were previously in place when we last had different corporation tax rates, were also brought into force on 1 April 2023.

A company is classed as associated with another company if, at that time (or at any other time within the preceding 12 months):

• one company has control of the other;
• both companies are under the control of the same person or group of persons

Associated companies are discussed further in my colleague Hannah Charlton’s blog here.

Bonus or dividends?

So, taking these new rules into account, what is the most tax efficient way to extract profits?

The short answer, and like most answers when it comes to tax, is “it depends”.

Example

The below table shows the net income retained by an individual if a company spent £1,000 overall on either a bonus or a dividend (assuming the individual has already utilised their dividend tax free allowance of £1,000).

It compares the position for a basic, higher and additional rate taxpayers where a company’s profits are at each of the small, marginal and large profit rates.

The table highlights that from April 2023 and using our illustrative amounts, dividends will be more tax efficient for basic rate taxpayers and companies with profits below £50,000, but a bonus will generally be more tax efficient for companies with profits within the marginal or upper limits.

Note, however, that this may not be the case if the bonus brings company profits down from the large and marginal rates to the small profits threshold, or if you have an individual who gets pushed from a basic rate payer to a higher rate payer due to the additional income.

Other points to consider

There are many other points to consider when deciding how best to extract profits, some of which are highlighted below:

• If a company undertakes R&D, a bonus may be more beneficial in order to maximise the R&D tax credit. Visit our R&D page.
• On the 6 April 2023, the pensions annual allowance increased from £40,000 to £60,000, making pension contributions a very attractive method of profit extraction.
• Dividends do not count as ‘relevant UK earnings’ and can therefore restrict tax relief on employee pension contributions.
• Dividends can only be paid out when a company has distributable reserves.

Overall, when it comes to remuneration planning, there is not now a ‘one size fits all’ approach and it is important to look at each position on a case-by-case basis.

If you would like any assistance in remuneration planning, please make contact with one of the Tax team, or your normal BHP contact 0333 1237171.