Tax efficiency

Optimising directors remuneration plus R&D tax credits

So here’s a recent conundrum posed at an R&D Tax Credits Group on Linkedin:

“Has anyone ever done an exercise on a company with a director say on £9000 salary per annum and £40k dividend v a director on £say 54K pa .Both doing 60% R&D . Say Profit £80 before salary and dividend . What goes to HMR&C and what cash does company retain in bank ? Bound to be someone keen to look at that ?”

Using the above example, I have tweaked it slightly to an overall director’s remuneration package of £42,475 (rather than £54k). This is because, if a director would like a remuneration package around this level,  this figure makes better tax sense as it uses the personal allowance and basic rate tax band (tax year 2012/13) with no income subject to higher rate tax.

Taking a baseline control position first, it is generally more tax efficient for a director/shareholder to extract profits from a company as a dividend rather than salary.

For these purposes, I have assumed that in the dividend scenario the director has utilised the personal tax free allowance of £8,105 then taken the remainder as dividend up to £42,475 (there is a marginally more tax efficient way to structure this but I am trying to keep things simple).

Dividends received within the basic rate tax band attract no further income tax plus no NICs for the director.

However, the company tax suffered is higher as dividends are non-tax deductible whereas salary is deductible for tax.

Nevertheless, the director would be better off in the dividend scenario to the tune of a £5,000 saving compared to a salary taking into account both net cash left in hand and in the company (post tax).

However, once we take R&D tax credits into account then the position reverses…

If we assume profits of £80k pre salary / dividend and that the director is engaged 60% in qualifying R&D and receives the 225% R&D uplift on salary costs then the director will be approx £6,000 better off receiving a salary compared to receiving dividends. Note that there can be no R&D uplift on dividends received – only on salary. 

This is some £10,000 improvement in tax savings from the baseline control position of salary and no R&D tax credit claim.

This shows that the default response of:

“A dividend is more tax efficient than a bonus”

can adversely impact on the overall tax profile of an owner managed company where R&D tax credits are available.

This is another example of the need to view a business and its shareholders’ tax position holistically – it all connects; it is dangerous to seek advice on one aspect of your financial and tax affairs without it having a knock-on effect elsewhere in your overall tax profile.

It is vital to crunch the numbers before agreeing a tax optimised remuneration package if you are to make the most of the UK’s fantastic R&D tax incentive scheme.

 

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