One of the headlines from Rishi Sunak’s recent Budget was a planned rise in Corporation Tax. We looked last month at how the chancellor’s statement will affect your clients, and a significant hike in business taxation is certainly a measure that will impact many firms – especially medium-sized and larger enterprises.
If your clients are looking to mitigate the rise in Corporation Tax scheduled for April 2023 then there are financial planning opportunities that could help. Read on for a couple of ways your clients can use sensible financial planning to mitigate their corporate tax.
How pension contributions can mitigate Corporation Tax and National Insurance costs
In his Budget, the chancellor announced that he was raising Corporation Tax for businesses with profits of more than £250,000 from 19% to 25%.
Businesses with profits below 19% will continue to pay a rate of 19%, while there will be a taper for firms earning between £50,000 and £250,000 in profits.
In addition to Corporation Tax, employers must pay National Insurance contributions (NICs) for their employees once their salary reaches certain thresholds. From an employer point of view, any employee earnings over £8,840 will attract a National Insurance payment of 13.8%.
Note that there are other thresholds depending on an employee’s age and their apprenticeship status. The government website has more details.
Of course, Corporation Tax is paid on the profits of a business. So, it follows that clients can deduct any costs incurred in running the businesses before profits are calculated. This includes pension contributions.
In addition to deducting pension contributions before Corporation Tax is calculated, contributions are also exempt from National Insurance at 13.8%.
Here’s an example, where a client might exchange £1,000 in salary for a pension contribution. This example also considers a scenario where, as the company does not pay National Insurance, the saving has been passed onto the client as an addition to the pension contribution.
So, if a client exchanges £1,000 of their earnings for a pension contribution, they would receive a full £1,000 in their pension (plus an additional £138 if the NI saving was passed on). This £1,000 is also Corporation Tax deductible.
Compare this to a client making a pension contribution from after-tax income where they will pay 20% Income Tax and 12% NICs on their salary.
You’ll see that making an employer contribution results in more money going into the pension fund, and lower tax and NI costs.
Remember that employer pension contributions must be made “wholly and exclusively for the purposes of the business” in order to receive Corporation Tax relief. This means the contribution should be at a reasonable level for the individual concerned.
Pension contributions from the business also help tackle Annual Allowance issues
If your client takes a small salary and larger dividends from their business, and then decide to make personal pension contributions, their tax relief might be limited by the rules concerning the pension Annual Allowance.
This is because dividends don’t count as “relevant UK earnings” when it comes to determining the tax relief available on pension contributions. For example, if a client earns £15,000 in salary and £20,000 in dividends, the maximum amount they can pay into their pension each year and benefit from tax relief is just £15,000.
While employer and personal pension contributions both count towards the £40,000 Annual Allowance, employer contributions aren’t limited by salary.
Clients should remember to make business protection payments from the company also
Relevant life cover is a type of life insurance that pays a lump sum to an employee’s family if they die while being employed by the firm. The employer pays the premiums and owns the policy.
If your client is currently making life insurance payments from their personal income, there are tax advantages to paying these premiums through their business.
For an employer, the cost of a relevant life plan is usually an allowable business expense, which means your client’s business gets tax relief on the premiums.
It’s also tax-efficient for the employee, as the lump sum is normally paid without attracting Inheritance Tax and it doesn’t form part of their pension Annual or Lifetime Allowances.
If appropriate, clients could consider cancelling their personal life insurance, switch to a relevant life plan and let their business pay the premiums.
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We’re here to advise you and your clients on all aspects of financial planning. If you have clients that would benefit from advice, or you’re interested in how you can work more closely with us, please get in touch. Email firstname.lastname@example.org or call 01454 416 653.