Limited company taxation for tax year 2023/24
When it comes to taxation, there are different rules for different types of businesses. For instance, sole traders and partnerships are taxed as if they were an extension of the individual's income, whereas companies are taxed differently. In this article, we will look at how taxation works for a limited company, and how it can impact your financial planning.
Corporation tax
Corporation tax is paid on company profits, which is the difference between company turnover and expenses. The current corporation tax rate is 19%, but from April 2023, the rates will be revised to:
- Small profits rate - profits up to £50,000 -19%
- Main rate - profits over £50,000 - 25%
- There is a Marginal Small Companies Relief that applies to profits between £50,000 and £250,000, which is 26.5%. To know more about corporation tax, read the ZATRS Accounting article on corporation tax changes 2023/24.
For instance, if your company makes a profit of £80,000, the first £50,000 will be taxed at 19%, and the remaining £30,000 will be taxed at 25%. You must report your corporation tax to HMRC using a CT600 CTSA (corporation tax self-assessment) return, along with a copy of your 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, while the CTSA return is due in 12 months after the end of the financial year.
Example: Let’s say your company's financial year ended on March 31, 2022. You need to pay your corporation tax by January 1, 2023, and file your CTSA return no later than March 31, 2023.
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
Directors of a company receive a salary which is subject to PAYE (Pay As You Earn) and NI (national insurance) like any other employment. This is deducted as an expense in reaching the 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, called dividend tax. The rates for dividend tax are lower than for other forms of income, reflecting that corporation tax has already been paid.
In a typical owner-managed company, where the directors and shareholders are the same, the norm is to take a small salary up to the NI level and dividend for the remainder. For example, if your company has a profit of £70,000, you could take a salary of £2,570 (the current tax-free personal allowance) and a dividend of £57,430.
Example:
Let's say your company's profit after tax is £70,000, and you take a salary of £12,570 and a dividend of £57,430. You would pay no income tax on the salary as it's under the personal allowance threshold. However, you would have to pay dividend tax on the dividend, which would be £9,620 based on the 2023/24 dividend tax rates and thresholds.
Personal allowance (£0 - £12,570) - 0%
Basic rate tax payer (£12,571 - £50,270) - 8.75%
Higher rate tax payer (£50,271 - £125,140) - 33.75%
Additional rate tax payer (£125,140 upwards) - 39.35%
Note: Dividend income is taxed 0% for the first £1,000.
Payroll, income tax, and NI
Directors of a company are considered employees, even if they control it. Therefore, the salary drawn from the company needs to be run under a payroll, and deductions made via PAYE. There are three elements to the deductions: income tax, employers’ national insurance and employees’ national insurance.
Example:
Let's say you pay yourself a salary of £30,000 per year. The income tax on your salary would be £3,486, and the employers’ national insurance would be £2,884.
You would also have to pay employee national insurance of £2,092.
National insurance
National insurance is only charged on earned income, such as salary, and not on dividends or rental income. There are two types of national insurance:
- Employee NI (Primary Class 1 NI): deducted from employees' wages, at 12.0% on earnings over £242 a week and at 2.0% on earnings over £967 a week (2023/24 rates).
- Employer NI (Secondary Class I NI): paid by employers, and thus sometimes called a "tax on jobs" - the rate is 13.8% on weekly pay over £175 (2023/24 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.
Optimum salary and dividends
The decision on the optimum salary and dividends split depends on a variety of factors, including tax rates, national insurance rates, and cash requirements of the company owner. For example, if the company owner needs cash for personal expenses, they may choose to take a higher salary and a lower dividend. On the other hand, if the owner doesn't need immediate cash, they may choose to leave the profits in the company as retained earnings, which can defer the tax liability. However, it's important to keep in mind that the tax liability will eventually catch up when the owner withdraws the funds.
When it comes to payroll, income tax, and national insurance, it's essential to understand the different types of deductions. For instance, income tax is charged on all forms of income during a tax year, including salary, dividends, rents, self-employment income, and interest.
On the other hand, national insurance is only charged on earned income, such as the salary drawn from the company. This means that dividends or income from sources like rent are not subject to national insurance.
For instance, suppose you are the director and shareholder of a small company with a turnover of £100,000. You pay yourself a salary of £12,570 and take the remainder as dividends. In this case, you will need to pay income tax on the salary portion of your income, which will be zero as it falls within the tax-free allowance.
However, you have to pay tax on dividends which will be £14,139 (£1,000 dividend allowance, up to £37,200 @ 8.75% and between £50,271 to £125,140 @ 33.75%). The company will also need to pay employers' national insurance on your salary, which will be £479 (1 3.8% on earnings over £9,100 per year). Therefore, your takeaway to home amount will be £68,771.
In order to reduce the amount of taxes paid, it is important to establish the optimal proportion of dividends and salary withdrawals for a director. It is advisable to consult with an accountant for professional advice on this issue.
In conclusion, running a limited company requires a good understanding of how taxation works. Corporation tax is paid on company profits, salaries and dividends are subject to income tax and national insurance, and the optimal split between the two depends on various factors. To avoid costly mistakes and ensure compliance with tax regulations, it's always best to seek professional advice from an accountant who can provide tailored guidance based on your specific circumstances.
The Handpicked Accountants profile for ZATRS Accounting can be found here.
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This article was written for Handpicked Accounts by Zahirul Abedin of ZATRS Accounting.
