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R&D – impact on director remuneration

It’s generally more tax efficient for a director shareholder to extract the majority of profit from a company as dividends rather than salary. But what if the company is undertaking R&D? Is this still the optimum remuneration strategy?

Example

You are the sole director in a company that undertakes some R&D.  The annual profit is estimated at £140,000 for the year ended 31 March 2016 before taking into account the director’s remuneration.

You might think that the most tax-efficient remuneration package is £10,600 for 2015/16 to cover the personal allowance and then net dividends of £28,606 to take the director up to the basic rate band. You also need to consider whether the company can make an R&D relief claim and, if it can, how this might affect your decision.

Salary vs Dividends

If the director takes a typical remuneration package, then the net tax and NI savings over taking a salary of £39,206 would be £5,265, assuming the £2,000 employment allowance is available.  This saving is made because 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 on profits retained for dividends.

Taking R&D relief into account

From 1 April 2015 the R&D tax credit for SMEs increased from 225% to 230%.  There is no R&D uplift on dividends received – only on salary. This means that paying a £39,206 salary would actually result in a saving over taking a small salary and dividends of £1,208.

What about a larger salary? In fact, 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 £1,366 after the R&D relief (assuming there was sufficient profit to offset the CT relief), whereas a salary of £10,600 and net dividends of £59,400 would result in net tax/NI of £5,883 – so the saving by taking a salary over dividends is £4,517.

HMRC will generally not accept 100% of a director’s salary costs within the R&D claim unless it can be clearly demonstrated that the director was exclusively involved in R&D activity.

Pension contributions

While dividends don’t qualify as eligible staff costs for R&D claims, company pension contributions do.  New pension freedoms make pension contributions a much more attractive option, so you might want to consider this as part of your 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 will be £55,200 (£40,000 x 60% x 230%). This means that the overall CT saving on the pension contribution will be £14,240 (((£40,000 x 40%) + £55,200) x 20%). As there’s no NI due on pension contributions, this is an even more efficient option than taking additional salary.

The default response of a dividend being more tax efficient than salary may not be applicable if the director undertakes R&D work for the company as there’s no R&D uplift on dividends. So it’s vital to crunch the numbers before agreeing the most tax-efficient remuneration strategy.

Get the best deal for yourself

For advice on the best split between salary and dividends or help with setting up a limited company and registering for VAT, please contact Alterledger.

What if you change a dividend to salary

Stress business woman

Let’s look at the case of Richard and Julie Jones v HMRC [2014] UKFTT 1082 (5 December 2014).

They took a small salary and regular dividends from their recruitment company which was absolutely fine until the company got into financial trouble!

Their accountant (unethically but in an attempt to help their client) suggested they should re-write history and change the dividends to salary so that the liquidator couldn’t recall the dividends.

HMRC then decided to demand PAYE and NI and pursued Richard and Julie personally.

HMRC was refused the right to collect PAYE tax and NI due on the salary, not because the law didn’t allow it, but because it wasn’t possible for Richard & Julie to reclassify the dividends. They had been properly paid and the correct procedure followed. History couldn’t be rewritten and the dividends should have been changed to loans if the dividends were illegal.

steve@bicknells.net

What are Directors Emoluments?

Businessman With Gold Bar

The reporting requirements are set out in The Large and Medium Sized Companies and Groups (Accounts and Reports) Regulations 2008, obviously emoluments include:

  1. Salary
  2. Bonuses
  3. Compensation for Loss of Office
  4. Benefits
  5. Share Options
  6. Long Term incentives
  7. Pensions

But it can also include payments made via other companies for ‘Qualifying Services’, these are payments paid in relation to the Directors services as a Director of the reporting company (Section 8, Part4, Paragraph 17).

In many cases this could be obvious for example if the Director used a Personal Service Company (PSC) or if the director invoices the company for management services or for management charges. But often invoices relate to the supply of products and services which don’t fall within qualifying services.

Its worth noting that unquoted companies with less than £200k for Directors Emoluments are not required to report details of the highest paid director.

Its also worth remembering that any related party transactions should be fully disclosed in the related party note, so is further clarification of what should be emoluments needed?

steve@bicknells.net

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