So, the controversial social care reform plans have been voted through the Commons, passing by 319 votes to 248. Predictably, the media and opposition parties have raised concerns over this being a regressive tax at a time when many working people are just finding their feet again after the Covid pandemic.
The double whammy of a 1.25% increase on employers and employees National Insurance may make many business owners look at alternative methods of remunerating themselves away from the usual combination of salary and or dividends. Here I look at some of the options available.
The Government has committed to doing away with petrol and diesel cars by 2030 as part their package of green initiatives.
Under the optional remuneration arrangement rules effective from 6 April 2017, obtaining a tax and National Insurance advantage by foregoing salary in exchange for a benefit in kind became almost impossible with only a few exceptions.
One such exception was where an employer leased an electric car with CO2 emissions of less than 75g/km. If the car was leased by the business and then to a Director or employee, rather than HMRC taxing the higher of the benefit in kind and the salary foregone, they have accepted that by default, they would only tax the benefit in kind.
With the benefit in kind percentage for 2021/22 being only 1%, a Tesla with a list price of £80,000 would only result in a benefit in kind of £800 and for a company Director paying tax at 45%, this would lead to a tax charge of only £360.
Of course, one needs to factor in the high cost of leasing the car itself but with the payments being made from gross salary, paired with the significantly reduced running costs and of course, the employer’s NI saving at 15.05% from 6 April 2022 (although the benefit in kind rate goes up to 2% from that date), it is quite an attractive proposition.
More commonly, salary sacrifice is used as a mechanism to ensure that payments into a company pension scheme can be made from gross salary.
This is far more convenient for the employee/Director because they do not need to make any claim for higher or additional rate relief through their Self-Assessment Tax Return.
The optimum zone for sacrificing salary is where earnings fall between £100,000 and £125,640, as the effective tax rate is 60% because of the loss of the personal allowance. Now with the 1.25% National Insurance increase as well, there is further incentive to utilise salary sacrifice.
One cautionary note would be to make sure that you do not exceed the annual allowance, which is reduced where earnings exceed £240,000. All individuals start with an allowance of £40,000 but by the time income reaches £312,000 this has become £4,000. If your employer also makes contributions, this limit could be inadvertently exceeded, meaning that the relief is clawed back at your marginal rate of tax. That could mean a 45% hit through Self-Assessment.
An often overlooked and unfortunate consequence of salary sacrifice is that the amount foregone does not feature in your total income for a mortgage application. That could be particularly frustrating if you fall short on funding for your dream house.
LTD v LLP
One of the key drivers for choosing an LLP over a limited company is the fact that employer’s National Insurance can be avoided unless the business is employing staff and operating payroll. The usual method of remuneration for Directors of a company would be a salary and dividends. Outside of the Fund Management arena, this would usually be by way of a salary within the Primary Threshold for National Insurance purposes, thus avoiding both employer’s and employee’s NI. The remainder would then be paid in dividends.
However, the Disguised Investment Management Fee rules stipulate that unless an arms length salary is being paid, any dividends bridging the gap could be treated as trading profit, meaning a higher rate of tax is payable.
Most LLP members receive a profit (or loss) allocation, which is subject to tax at their marginal rate, along with Class 2 (£159 per annum) and Class 4 National Insurance. Although Class 4 will now rise to 10.25% at the main rate and 3.25% at the higher rate, the increase to employer’s NI and dividend tax is not an issue.
Proprietors of fund LLPs need to keep in mind that although they will save the additional 1.25% employer’s and employee’s National Insurance by not employing members, those members need to be taking an active role in the business in order to avoid the ‘Salaried Member’ anti-avoidance rules. For some time now, HMRC have been looking to tighten the rules to ensure that Fund Managers, for example, are not simply being added as members to avoid the employer National Insurance.
It is likely that this levy will be here to stay with views being split evenly on whether this was the right way to raise much needed funds.
Whilst in the first year it will impact National Insurance rates, from 6 April 2023, it will be collected through the introduction of a separate levy on earnings. As that levy is still based on earnings (whether employment or trading income), salary sacrifice would still be effective in reducing the impact slightly.
An LLP has, in recent history, been the vehicle of choice for Hedge Funds and no doubt it will continue to be after the announcement this week due to the increase in employers NI from 13.8% to 15.05%.
Contact me Paul Webster, head of Private Client Tax, to discuss further.