As a business owner, extracting profits tax-efficiently requires ideal corporate tax planning. We’ll help you do exactly that in this guide, by helping you become familiar with the aspects you need to keep in mind.
We will cover:
- Tax considerations of extracting profits
- How to plan for tax-efficiency
The method in which the business is set up will affect how some business owners extract profit and their tax position in the event of a later disposal of the business.
• Tax-free interest on savings: the £1,000 personal savings allowance (reduced to £500 for higher rate taxpayers) and the £5,000 savings nil-rate band provide an opportunity to extract profits from the company tax efficiently by way of loan interest.
• This savings band is not affected by the receipt of dividend income and is available in addition to the £1,000 nil rate band on dividends.
• No National Insurance is payable on interest, so this can be an efficient way of extracting profits.
• Where a director has sufficient funds to lend to their own company, they may lend to it at a commercial unsecured rate.
• The company may be able to obtain a tax deduction for the payment of interest as long as the loan is used for an allowable purpose: it is advisable to create a formal loan agreement and for the company to have a business plan that will explain how funds are being used, if it is not otherwise obvious e.g. funds lent to purchase plant or a property.
• The company has to deduct basic rate tax from payments of interest and complete a CT61: the director can then reclaim the tax if it is within their personal savings allowance.
Salaries and remuneration
• The company may declare dividends to shareholders when profitable, provided that it has sufficient distributable reserves.
• The first £1,000 of any dividend is tax-free for 2023-24. This reduces to £500 for 2024-25. Dividends in excess of this amount are taxed at 8.75% (basic rate), 33.75% (higher rate) and 39.35% (upper rate).
• Dividends are not subject to NICs and are paid out of post-tax profits, i.e. there is no available tax deduction for the company.
• Dividends are taxable as income in the hands of individuals, they are often exempt distributions when received by other companies.
Is the owner planning to retain profits within the company?
• Using a company as a temporary money box may be a strategy for taxpayers wishing to avoid higher rates of tax, or tax at marginal rates (including a clawback of Child Benefit payments through the High-Income Child Benefit Charge).
• It is sensible to watch the level of cash in the balance sheet if a company sale or retirement is planned.
• On one part, if this is too high and there is a significant drop in trading the combination of the two may affect trading status in terms of Capital Gains Tax (CGT) and Inheritance Tax (IHT) Business Property Relief.
• In some cases where it is decided to strike off or wind up a company in order to extract its profits as a distribution in respect of capital, CGT relief may not be available if a company owner recommences a similar business within two years.
➤ The Targeted Anti-Avoidance Rule (TAAR) is aimed at preventing the practice of ‘Phoenixing’, closing down one company and starting another in its place.
• The Transactions in Securities rules help ensure that company owners do not avoid Income Tax by taking advantage of CGT rules. Whilst most company owners were happy to ignore the TIS rules in the past they are now so widely drafted that need to be considered in any tax planning exercise involving share capital.
Is it appropriate to consider running an LLP in parallel to the company?
• If individuals are running several businesses, a Limited Liability Partnership (LLP) may be a useful structure to run alongside a company.
• With some careful planning, the LLP can be used to take advantage of the different tax rules between company and LLP and achieve maximum flexibility. For example, an LLP could be used to provide (and charge for) services to the company allowing for profit extraction.
Is it possible to split income with spouse or family members to mitigate tax?
• Can a salary or bonus, or other benefits be paid to working family members?
• Ensure that any earnings, including benefits, are proportionate to the role within the business.
• Employing a family member will allow a single director company to claim the Employers’ NICs allowance provided that both employee and director are paid above the NICs secondary contributions limit.
• Different classes of shares would enable different levels of dividend to be paid, see ABC or alphabet shares.
• All shareholders receive £1,000 dividends free of tax for 2023-24.
• Spouse exemption: ensure the property is gifted outright, or is not wholly a right to income e.g. a dividend waiver and try to avoid paying income into joint accounts.
• Minor children: an income gift from a parent is ineffective if income is> £100 per year. · Family members can be given shares: they can be exempt from the Employment-Related Securities provisions.
• CGT will apply on any gift of shares and for Inheritance Tax (IHT) a gift will become chargeable if the giver dies within seven years of making the gift unless a relief applies.
• CGT may be avoided through the use of a Trust, see also Family Investment Companies.
• The settlement provisions do not apply to capital gains.
Tax-free benefits and taxable Benefits In Kind
• Electric cars & vans.
• IT equipment, including tablets, laptops, iPads.
• Mobile phones.
• Subsidised travel.
• Small loans.
• Staff parties (£150 per year).
• Trivial benefits (£300 per year).
• Pensions advice (£500 per year).
• Lunch and refreshments (works canteen rule).
• Workplace electric car charging facilities.
• Working from home allowance of £6 per week.
• Review pension arrangements.
• Company contributions do not give rise to any tax or NIC charges for the employee.
• The company can obtain a deduction for the contributions made wholly and exclusively for the purposes of the company’s trade.
• The company can contribute up to the director’s annual allowance of £60,000 per year as part of a reasonable overall remuneration package before a personal Income Tax charge arises (maximum is £60,000 including growth).
• The lifetime allowance is maintained at £1,073,100 for 2023-24.
The annual allowance taper thresholds for 2023-24 are:
• The threshold income is £200,000.
• The adjusted income is £260,000.
• The minimum tapered annual allowance is £10,000.
Review taxable benefits
• Company cars: could a vehicle switch result in a lower tax charge?
• A Van for family members? Certain vans e.g. luxury seat pack models are now treated as cars.
• Mobile phone contract discount for family?
• Medical and health insurance.
• Assets such as company cars, vans, bicycles etc may be sold to a director when a few years old at a significantly lower price than when new.
• If the company hosts regular golf days or other sporting events it may own equipment that may be lent to the director for weekend use. Any associated Benefit In Kind calculated under the general 20% charging provision is apportioned for the time when made available to the director. Any agreement should be documented by the company and the asset must genuinely be under the company’s lock and key when not available.
• Personal Service Companies: note changes to travel & subsistence rules from April 2016.
• Note that PAYE dispensations have not been valid since April 2016: most expenses can be reimbursed provided that they are incurred wholly, necessarily and exclusively for the purposes of the employment.
Loans instead of pay
• Provided that the company is solvent, consider lending cash to directors as an alternative to dividends.
• A loan cannot be substituted for a salary or a bonus if there is already a contractual entitlement to remuneration.
• A loan to a participator in a close company will be subject to Corporation Tax under section 455 CTA 2010 if not repaid within nine months of year-end.
• Loans made prior to 5 April 2016 are charged at 25%, loans made from 6 April 2016 onwards are charged at 32.5%. From 6 April 2022, this increased to 33.75%. This is refundable nine months after the end of the accounting period in which the loan is repaid, written off, or released.
• There is no Income Tax or NICs on a loan, however, the company will need to charge interest at the official rate (currently 2%) on loans of more than £10,000 in order to avoid a taxable benefit.
• Do you rent your home to your company? Does it use any commercial property that you own privately?
➤ You may charge your company rent.
• The owner must declare rent received less expenses (mortgage interest and services) under Self Assessment. The company receives tax relief on the payment.
• Since 2021-22, mortgage interest does not benefit from higher rate tax relief.
• Is a licence in place, with supporting board minutes to agree rent and any services provided?
• Any licence for use of home should grant non-exclusive use so as not to affect CGT Private Residence Relief.
• Review capital assets to make sure it is still suitable to hold them outside the company, considering:
➤ If charging rent there can be restrictions on:
▷ Business Property Relief for IHT.
▷ Business Asset Disposal Relief (formerly Entrepreneurs’ relief) for CGT.
▷ Private Residence Relief when selling your main residence.
What to consider when extracting a mix of salary, dividend and rent?
• Is a salary tax efficient compared with dividends for family members, especially bearing in mind the £1,000 Dividend Allowance for 2023-24?
• Are there any loans to the company on which interest can be charged, utilising the Savings Allowance?
• For Corporation Tax relief: check that the rent charge is reasonable on an arm’s length basis, rental charges over market value will not be entitled to a tax deduction.
• When charging rent on a personally owned property used in the business, consider the impact on Business Asset Disposal Relief.
• Can an asset be transferred into a Self-Invested Personal Pension (SIPP) as a contribution in specie?
• Can a pension fund a commercial property purchase?
In conclusion, you can extract profits from your business in a tax-efficient way by considering different aspects that you can use in combination.
We can help you structure the most tax-efficient strategy to extract profits from your company. Contact us to find out more.
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Kind regards Ilyas