The new employment allowance could cut your bills by £2,000. But are all businesses eligible and what effect does this measure have on remuneration planning for a one-man company?

The employment allowance (EA) became available to employers from 6 April 2014 to set against their secondary (employer) Class 1 NI liability (National Insurance Contributions Act (NICA) 2014 ss. 1-8) . The allowance is the lower of £2,000 and the amount of the employer’s secondary Class 1 liability for the tax year (less excluded liabilities).

Excluded employers. Most businesses should be able to claim the EA, but there are some notable exceptions, including businesses (but not charities) that carry out functions either wholly or mainly of a public nature, e.g. GP and NHS dental practices, and employers of domestic staff such as nannies, gardeners and cleaners.

One-man companies? There’s no minimum number of employees needed in order to qualify for the EA so it’s available one-man businesses and can be set against any secondary Class 1 NI liability due on the director’s salary but following the introduction of the EA.

A popular strategy used to be was to pay the director a minimal salary equal to the secondary NI threshold (£7,956 per year for 2014/15). The remainder of their remuneration (as long as there are sufficient retained profits available) is then taken as dividends. So what’s the impact of forsaking the EA and continuing to adopt this approach for 2014/15?

Scenario 1. Helen is the sole shareholder and director of her company, H Ltd. The company prepares accounts to 31 March each year and for the year to 31 March 2015 expects to make a profit before taking account of salary and tax of £40,000. Helen pays a small salary for 2014/15 of £7,956 and takes the rest of the profit as dividends.

Tax position. There’s no income tax to pay on the salary as it’s covered by Helen’s personal allowance (£10,000 for 2014/15). The salary is deductible for corporation tax (CT) purposes, leaving taxable profits of £32,044 on which CT of £6,408.80 (£32,044 x 20%) is payable. This leaves profits of £25,635.20 available to take as dividends. As Helen’s taxable income does not exceed the basic rate limit, there’s no further tax to pay.

Result. Helen retains £33,591.20 (£7,956 + £25,635.20) of the profits for the year.

For 2014/15, it may seem attractive to pay a higher salary in order to take full advantage of the EA. To achieve this, annual earnings must be at least £14,493 (£2,000/13.8%) above the secondary NI threshold for the year. This equates to a salary of at least £22,449.

Scenario 2. Helen decides to draw a salary of £22,449 and take the remaining profits as dividends.

Tax position. After allowing for her personal allowance, Helen will pay tax of £2,489.80 on her salary ((£22,449 – £10,000) x 20%). She will also pay primary Class 1 NI on the salary of £1,739.16 ((£22,449 – £7,956) x 12%). This leaves Helen with net pay of £18,220.04. The secondary Class 1 NI due on a salary of £22,449 before allowing for the EA is £2,000.03. The EA of £2,000 is set against this, effectively cancelling out the liability (bar 3p!). The salary is deductible for CT purposes, leaving taxable profits of £17,551 on which CT of £3,510.20 is payable, leaving £14,040.80 to take as dividends.

Result. Helen retains £32,260.84 of the profits for the year so she’s actually £1,330.36 worse off than under Scenario 1.

An alternative approach is to pay a salary equal to the personal allowance for the year and extract the remaining profits by way of a dividend. The secondary NI liability that would arise to the extent that the salary exceeds the secondary threshold is covered by the EA, but primary NI is payable by the director. As the salary is covered by the personal allowance, there’s no tax to pay.

Scenario 3. Helen pays a salary equal to the personal allowance of £10,000, withdrawing the remaining profits as dividends.

Tax position. She pays primary Class 1 NI on the salary of £245.28 ((£10,000 – £7,956) x 12%), leaving her with net pay of £9,754.72. The secondary NI (£282.07) is covered by the EA. After deducting the salary, the company has taxable profits of £30,000 on which CT of £6,000 (£30,000 x 20%) is payable, leaving £24,000 to take as dividends.

Result. Helen retains £33,754.72 of the profits – £163.52 more than under Scenario 1.

Forsaking most of the EA will allow the director to maintain more of the company’s profits, though it can be slightly advantageous to pay a salary equal to the personal allowance rather than the primary and secondary NI threshold.

For one or two-man companies (in fact this works for up to several directors), it would be better to pay each director a salary equal to the personal allowance (£10,000 for 2014/15) rather than just up to the NI thresholds.