Re-thinking remuneration strategy following loss of Employment Allowance
In April 2014 the National Insurance Employment Allowance was introduced which enabled employers to reduce their NIC liability by £2,000. The same rate remains in force for this current tax year.
In true giving away with one hand but taking away with another, George Osborne announced in this year’s Summer Budget that the allowance would be increased to £3,000 from April 2016 but withdrawn for companies where the director is the sole employee. The loss of the allowance will cause many contractors to revise their salary calculations.
As a general rule it is efficient for a director of a PSC to pay a small salary to preserve their entitlement to the state pension and certain contributory benefits, and to extract any remaining profits from their company by way of dividends. To ensure pension entitlement the salary must be at least equal to the NIC lower earnings limit. For 2015/16 this is £112 p.w/£5,824 p.a.
Employee’s NIC is payable at a notional zero rate, so it is possible to pay a salary of up to £8,060 without incurring a tax or NIC charge, provided the director is not in receipt of any other income that may affect their personal allowance.
Salaries in excess of £8,060 (the annual primary threshold) mean that the director will pay Class 1 NIC of 12%. Ordinarily, employers would also have to pay NIC at 13.8% on salaries exceeding £8,112 but because of the availability of the Employment Allowance, the employer does not pay any contributions until NIC for the year tips £2,000. This means that, assuming personal allowance being in tact, for the current tax year, it is better to pay a salary of £10,600 and pay employee’s NIC of £304.80 than to pay a salary of £8,060 and take the rest of profits as dividends. This is because no employers NIC is due as it is absorbed by the Employment Allowance. The salary is deductible for corporation tax so the additional salary of £2,540 results in a saving of corporation tax of £508. The overall net saving is therefore £203.20 (£508 – £304.80).
A salary in excess of the personal allowance will be taxed and coupled with the employee’s NIC will be greater than the corporation tax saving.
From April 2016 however the benefit of paying a salary in excess of the NIC primary threshold is nullified by the removal of the Employment Allowance for PSCs. The optimum salary will therefore be reduced to one that is equivalent to the higher of the primary threshold (employees) and the secondary threshold (employers). It will no longer be beneficial to take a salary where both employees’ and employers’ NIC are payable. If only employee’s NIC or employer’s NIC is payable, then the corporation tax deduction will offset this.
With the new dividend taxation rules also coming into force next year, this will have a further impact on a contractors’ remuneration planning.
Had there been any clarification around whethe this still holds true for companies with 1 employee?
i.e. Husband and wife, where one is a director and the other is secretary and draws a salary.