While there are limits on the amounts that can be contributed, this is an obvious alternative to the tried and tested dividend route, which would allow profit extraction with a lower effective tax burden – while acknowledging that these are funds that the business owner is unlikely to be able to utilise for several years.
With the announcement that corporation tax rates are set to increase from 2023 onwards, the effective rates of tax on dividends for additional rate taxpayers will increase to an alarming 54.51 per cent compared to just 40 per cent six years ago, and will make many business owners challenge the mantra of the Conservatives of being a low-tax party for the entrepreneurs of this country.
This means that advisers will be considering if remuneration strategies should be increased in the current tax year at lower tax rates to reduce the impact of future tax rises. The disadvantage is that this will increase near-term tax liabilities and payments to HM Revenue & Customs, which the government is counting on to help provide a windfall to help fund the gap in finances caused by the Covid-19 pandemic.
Given the economy remains fragile, and the introduction of the health and social care levy makes employment more expensive, it is a gamble by the government that businesses are strong enough to bounce back with these additional tax burdens.
Advisers and their clients will be discussing the tax burden versus cash flow impact of taking additional dividends from businesses if they are in the fortunate position that their business has weathered the Covid storm successfully and are able to make such a payment.
As an example, an additional dividend of £100,000 that can be taken either in the current tax year or subsequent two years where all the dividend is subject to the additional rate of income tax:
Tax year | Tax arising on dividend of £100,000 | Payment date |
2021-22 | £49,860 | January 31 2023 |
2022-23 | £50,870 (additional £1,010) | January 31 2024 |
2023-24 | £54,510 (additional £3,640) | January 31 2025 |
On the basis that this is an additional one-off dividend, the impact on payments on account has been disregarded as it is expected that these will be adjusted to reflect the ongoing level of remuneration. As can be seen, by paying dividends in the current tax year there is a saving of £1,010 versus the following tax year.
There is an additional 12 months to pay the liability, but I suspect this difference will not change the conversation too much. However, in the run up to the following year the difference is an additional £3,640 of tax for an extra 12 months to pay the liability. That, I suspect, will be a facilitator in bringing forward dividend payments, for those businesses that can afford it.
Wait and see
