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1st September 2015
Posted in Articles, Business Tax, Corporation Tax, Featured Articles, R&D by Tom Minnikin
It is generally more tax efficient to extract funds from a company by dividends rather than taking a salary (dividends are exempt from National Insurance and, under current rules, effectively tax free up to the basic rate band).
However, if the company is an SME and is undertaking Research and Development (R&D) this may not necessarily be the case. This is because the R&D tax credit applies to salary and employers’ National Insurance but not dividends. An owner-manager who is heavily involved in R&D may find themselves better off paying themselves a salary in order to benefit from the extra corporation tax relief.
Example
Mr Dyson is the director-shareholder of Vacs ‘R’ Us Ltd, which has annual profits of £90,000. Like many owner-managers, Mr Dyson takes a salary up to the personal allowance of £10,600 and, after paying corporation tax, extracts the rest in dividends. This results in net take home pay of £65,676. If he pays himself wholly in salary he takes home only £53,767. He is £11,909 better off.
After reading Forbes Dawson’s recent tax bite on R&D (see here), Dyson realises his company qualifies for R&D in respect of a new hand drier product he spent the last two years developing. He estimates that he spent 85% of his time working on the R&D project.
As he paid himself mainly with dividends this cannot be included in the R&D tax credit, resulting in R&D relief of only £2,418.
However, if he remunerated himself with salary the R&D relief would have amounted to £19,890.
With the tax refund Mr Dyson could pay himself a dividend resulting in net take home pay of £68,684. He is now £1,195 better off.
| Profits available: |
£90,000 |
|
£90,000 |
|
| Company position: |
Current route (£): |
|
Salary route (£): |
|
| Salary | (A) |
(10,600) |
(80,070) |
|
| Employers NIC (@ 13.8%) | (B) |
(343) |
(9,930) |
|
| Profits before tax |
79,057 |
– |
||
| Corporation tax (@ 20%) |
(15,811) |
– |
||
| Net profits payable as dividend | (C) |
63,246 |
– |
|
| Director’s tax position (prior to R&D): | ||||
| Amount received (A + C): |
73,846 |
80,070 |
||
| Tax on salary |
– |
(21,431) |
||
| Employee’s NIC on salary |
(305) |
(4,872) |
||
| Tax on dividend |
(7,865) |
– |
||
| Net take home pay |
65,676 |
|
53,767 |
|
| R&D relief (130% x (A + B) x 85%) @ 20%: |
2,418 |
19,890 |
||
| (paid out as a dividend) | ||||
| Additional tax payable |
(605) |
(4,973) |
||
| Net take home pay (after R&D): |
67,489 |
68,684 |
Summary
The analysis will vary from case to case but savings could arise for a company with profits of £75,000 or more where there is an owner-manager spending over 75% of their time on qualifying R&D. This is even more true from April 2016 when new higher tax rates for dividends kick on. The owner-manager would possibly only need to be spending 50% of their time on R&D to benefit.
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