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Limited Company Taxation

How Tax works with a Company

Whereas a Sole Trader or Partnership is taxed as if it is an extension of the individuals income, a company is taxed differently.

  • Corporation Tax is due on profits.
  • Directors receive a salary which is subject to PAYE and NI like any other employment – this is deducted as an expense in reaching profit on which Corporation Tax is due.
  • Shareholders can receive some or all of the profit after Corporation Tax as a dividend, which is taxed as personal income – Dividend Tax (a form of Income Tax) is applied at a lower rate to dividend income than other income, reflecting that Corporation Tax has already been paid.

In a typical owner managed company where the Shareholders and Directors are one and the same, the norm is to take a small salary up to NI level and dividend for the remainder – but there are a number of inter related issues here, and its easy to fall into traps – an accountants advice is best for your personal circumstances.

 

Corporation Tax

Corporation Tax is currently 19% (2022-23) on company profits – which is turnover less expenses.

Corporation Tax is reported to HMRC on a Ct600 CTSA (Corporation Tax Self Assessment return) along with a copy of the business accounts in a special format known as iXbrl.

The Corporation Tax is due 9 months and a day after the end of the financial year, and the CTSA return due in 12 months after the end of the financial year.  EG:

  • Financial year to 31 March 2022
  • Pay Corporation Tax 1 January 2023
  • File CTSA return no later than 31 March 2023

Corporation Tax changes from April 2023:

  • Main Rate of Corporation Tax rises to 25% where profits over £250k
  • Up to £50k profits at 19%
  • Taper between £50k and £250k
  • Caution these thresholds are split equally between connected companies, so if you operate two or more companies, take advice, especially if profit is not equal in each.
  • See our briefing on Corporation Tax Rate Rise 2023 – Impact

 

Salaries and Dividends

Salaries and Dividends are often confusing.  Remember:

  • Salaries are a reward for work done
  • Dividends are a return on investment in shares

In a small company Directors and Shareholders are normally the same, so there is merit in looking for the optimum salary / dividend split.    Depending on personal circumstances that tends to be a Salary of around £10,000 to £12,000 and the remainder as dividend.  There are a few factors which impact this, notably

  • Tax rates
  • NI rates
  • Cash requirements by the company owner

On the last point, cash requirements, company funds which aren’t needed immediately can be left as retained profit in the company, which defers tax, however the tax will catch up with you when you withdraw the funds, although if you anticipate having a time when you won’t be earning as much there can be merit in retaining profits until then and drawing them at a lower tax rate.

 

Payroll, Income Tax and NI

Directors are considered employees of the company, even if they control it.  Therefore the salary drawn from the company needs to be run under a payroll and deductions made via PAYE (Pay As You Earn).

There are three elements to the deductions here:

  • Income Tax on the salary – often this will be £nil as the typical small directors salary will be under tax allowances
  • Employers National Insurance – this is borne by the employer, so in the company accounts there is an expense for directors salary plus the Employers NI.
  • Employees NI.  This is a deduction from directors salary as it is borne by the employee.
  • From 2023-24 there will be Health and Social Care Levy as well, subsumed into NI.

Payroll generally needs to be run monthly and reported electronically to HMRC via RTI contemporaneously.

 

National Insurance

This is only charged on earned income, eg the salary drawn from the company.  It is not charged on dividends or income like rent.

Employees NI (Primary Class 1 NI) is deducted from employees wages, at 13.25% on earnings over £190 a week and at 3.25% on earnings over £967 a week (2022/23 rates).  In the 2022 Spring Statement on 23 March 2022, the starting threshold for Employees NI was raised to £242/w from 6th July 2022.

Employers NI (Secondary Class 1 NI) is paid by employers, and thus sometimes called a “tax on jobs” – the rate is 15.05% on weekly pay over £175 (2022/23 rates).

National Insurance is charged per source – so if you had two employments for example, or an employment and a self employment, they are assessed to NI separately.

 

Income Tax

Income Tax is charged on all income during a tax year, eg:

  • Salary
  • Dividends (special tax rates as they are from taxed profits)
  • Rents
  • Self Employments as a Sole Trader/ Partner
  • Interest

The tax rates (2022/23) are:

  • £0 to £12,570 – 0%
  • £12,570 to £50,270 – 20% – Basic Rate Band
  • £50,270 to £150,000 – 40% – Higher Rate Band
  • over £150,000 – 45% – Additional Rate Band

The £12,570 0% Personal Allowance tapers out on Incomes over £100,000 at £1 tapered deduction for each £2 of income over £100,000 creating a 60% marginal rate.

Income Tax is aggregated – so all sources of income are added up and the bands above applied.  Normally the calculation is in slices as follows:

  • Savings income is the first slice
  • Salaries and rental income is the next slice
  • Dividends are the top slice

However this slicing order can be overridden if it saves you tax.

As mentioned, as dividends have come out of company profit on which tax has already been paid, they are subject to a special rate:

  • There is a £2,000 Dividend Allowance (which was £5,000 in 2016/17 and 2017/18) – note the DA is part of the regular Basic Rate and Higher Rate bands, and not separate – it is a nil rate on that slice of dividend within the regular tax band
  • Dividends over £2,000 are taxed as follows:
    • 8.75% If they are in the Basic Rate Band
    • 33.75% if they are in the Higher Rate Band
    • 39.35% if they are in the Additional Rate Band

Assuming 19% Corporation Tax band (2022/23) this makes the marginal tax rate on dividends as follows (using the example of £1,000 pre tax profit):

Dividend Marginal Rates
£1,000 pre tax profit Corporation Tax Dividend Dividend Tax Rate Dividend Tax £ Total Tax £ Effective Marginal Rate
1,000 190 810 8.75% 71 261 26.1%
1,000 190 810 33.75% 273 463 46.3%
1,000 190 810 39.35% 319 509 50.9%

 

These marginal rates change with the change to Corporation Tax in 2023/24.   If your Corporation Tax rate was the full 25% they would be as blow:

Dividend Marginal Rates – 2023/24 Corporation Tax changes and profits over £250,000
£1,000 pre tax profit Corporation Tax Dividend Dividend Tax Rate Dividend Tax £ Total Tax £ Effective Marginal Rate
1,000 250 750 8.75% 66 316 31.6%
1,000 250 750 33.75% 253 503 50.3%
1,000 250 750 39.35% 295 545 54.5%

 

However due to the tapering inherent in the new Corporation Tax regime the actual marginal rates will be lower unless profits are over £250,000.