It’s generally more tax efficient for a director shareholder to extract the majority of profit from a company as dividends rather than take it as a salary. But what if the company is undertaking R&D? Is this still the optimum remuneration strategy?
Here’s the scenario. A web development company undertakes some R&D on which the sole director spends 60% of his time throughout the year. The annual profit is estimated at £140,000 for the year ended 31st March 2017 before taking into account the directors remuneration. The client would obviously want the most tax efficient remuneration package. What we really need to consider here is whether the company could make an R&D relief claim and if it can, what advice would we look to give you?
Salary and dividends
If the director takes the usual remuneration package, the net tax and NI savings over taking a salary of £43,000 would be £3,267, assuming the £3,000 employment allowance is available (see our blog on Payroll and Auto Enrolment). This saving is generated as dividends received within the basic rate band attract no further income tax plus no NI for the director or the company. This more than outweighs the additional corporation tax suffered as dividends are non-tax deductible whereas salary is.
Taking R&D relief into account
Since 1st April 2015, the R&D tax credit for SMEs has increased from 225% to 230%. However, there can be no R&D uplift on dividends received – only on salary. So paying a £43,000 salary would actually result in a saving over taking a small salary and dividends of £3,644. What about a larger salary? If the client wanted to take out more than the basic rate band, then the salary may become even more tax efficient. A £70,000 salary would result in net tax/NI due of £1784 after the R&D relief (assuming there was sufficient profit to offset to corporation tax relief), whereas a salary of £11,000 and net dividends of £59,000 would result in net tax/NI of £8953 – so the saving by taking a salary instead of dividends is £7,169.
It is worth noting that HMRC will generally not accept 100% of a director’s salary costs within the R&D claim unless it can be very clearly demonstrated.
Pension contributions
Whilst dividends don’t qualify as eligible staff costs for R&D claims, company pension contributions do. With the new pension freedoms making pension contributions a much more attractive option, a client may want to factor these in to their remuneration package.
If a company makes pension contributions of £40,000 for the director and they spend 60% of their time on R&D, the R&D relief on this would be £55,200. This means that the overall corporation tax saving on the pension contribution would be £14,240. As there’s no NI due on pension contributions, this is an even more efficient option than taking an additional salary.
It is vital that you explore all of your options first, before agreeing the most tax-efficient remuneration strategy. The world of tax is always changing, make sure you don’t get caught out and speak to us today.
