Remuneration planning: Focus on the road ahead by All in Place

Remuneration planning: Focus on the road ahead by All in Place

The demand for higher wages and salaries is everywhere. In a tight labour market many accounting firms and their clients will struggle to offer an old fashioned 2–3% pay increase, that felt easy to process, with relatively little financial pain to the employer. The private sector has had to flex to meet higher pay awards, with Office for National Statistics (ONS) data indicating pay awards in the private sector at over 7% currently.

Basic economics says that shareholders are rewarded when profits are high, but face reduced dividends when the going gets tough. Currently, it feels like we’re in the tough zone.

SME owner earnings

How much can your SME owner expect to earn now? Psychologically, paying a tax charge at the basic rate level feels OK on dividends extracted from a business, doesn’t it? Old school it was 7.5% versus 32.5%.

Putting to one side the pandemic impact (if that’s possible) on small and medium-sized enterprises (SMEs) and the owners’ personal earnings, a basic rate taxpayer with a tax-efficient national insurance (NI) salary and dividend structure might have taken home some £47,500 in the tax year to the end of March 2022.

If your client had two children you might have advised they keep within the £50k level, thus maximising the non-taxable child benefit to provide an all-in net cashflow of approximately £49,175.

The problem is your client will have been impacted by inflation, both in 2022, and anticipated to continue, throughout 2023.

It is estimated that your client would now need something like a net £57,460 to have the same purchasing power as they did in the 21/22 tax year – a whopping 17% to cover the cost-of-living crisis, inflation for last year and estimated for this year.

What’s the number?

So what is your client number then? Well, it will all depend on the client’s corporate structure, the number of business owners and so on.

A base case scenario could easily be two people in business together, operating through a limited company.

Having survived the pandemic the example expands on the idea above of the “£50k” client. In the 21/22 tax year the two business owners would have targeted a profit before tax of just over £101, 500 to cover their dividend needs, assuming a salary of £8,840 has already been drawn. 

In order to maintain the same purchasing power for the next 12 months the numbers are mind-boggling. The two owners will lose child benefit as their gross incomes will need to be over £60k. Furthermore, they have the 1.25% surcharge on dividends, the lower dividend allowance and a marginal corporation tax rate of 26.5% to contend with.

All up, it is estimated that the profit before tax would have to target just under £150,000 up from £101,500, a 47% increase, after a salary charge of say £9,100.

Interestingly the corporation tax take would almost double with this uplifted targeted profit-up from £19,300 odd to some £35,900. It feels like the burden for topping up the Exchequer’s coffers falls squarely on the small business owner.

Remember, this is all just to stand still. Inflation has not only impacted our daily costs, but the Chancellor has kept tax bands in check (or worse, brought the additional rate into a lower starting level).

Remuneration planning is made even harder when factoring in the impact of funding additional payments on account.

Corporate structure

So would changing the corporate structure make things easier then? Nothing in life is straightforward. But the starting point should be to understand your clients’ actual cashflow needs for the next couple of years and tie them back to the remuneration planning together with the wider business plan. Chasing an income to keep below the basic rate band simply doesn’t help, if your client can’t afford to pay their mortgage.

Also, it is vital that accountants understand their clients’ property plans and mortgage needs before planning either remuneration or a corporate restructure.

Mark Harris, chief executive of SPF Private Clients, says: “SME owners who require a new mortgage, refinance or extra borrowing, are encountering particularly challenging circumstances, with rising interest rates and the cost of living impacting affordability. On top of this, depending on what area their own business is focused on, profits may be flat, or they may even be sitting on losses, which won’t help their case.

“Owners of profitable companies may be well used to re-mortgaging at the end of their deal onto another competitive rate without too much trouble. But some business owners are finding that with their company not performing as well as in the past, this is it not as straightforward, impacting how much they can borrow and the rate they pay.”

Quite simply, there are unintended consequences if accountants are providing remuneration advice without a grip on personal finances in the current economic climate.

Not just a rear-view mirror

We live in uncertain times. What will happen to interest rates, property valuations and inflation?

Your clients will expect you to have an opinion, if not the answer. What does help is understanding your clients’ personal cashflow needs for the future, taking account of the impact of inflation and interest rate changes, so you can help them drive business profitability to secure their lifestyle. This is pure and simple all about accounting and giving your clients the best service you can.

Keeping within the basic rate tax band may have been the historic mantra for your client, but personal solvency and mental wellbeing might, just might, be more important now, unless the Chancellor can pull a rabbit out of the hat in the Budget.

The rear-view mirror may show basic rate tax needs, but the road ahead looks somewhat different, so concentrate on what’s going to happen, while also looking behind you. An analogy for life, not just the road!