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How to efficiently extract business profits

Once a company has paid taxes, bills, wagesand other expenses, what’s left is profit – but it can take time for a new firm to reach this point, and directors may need to convert their hard work into fiscal reward sooner.

Here are 5 tax-efficient tactics for business owners to extract profit from their companies:

Salary and Bonuses

The most obvious way for a company director to receive profits is to be paid a salary. To achieve maximum tax efficiency, it’s sensible to take a minimum salary.

Most people are entitled to a tax-free allowance (£11,500 in the current tax year) after which they pay 20 percent if they earn between £11,500 to £45,000; 40 percent, between £45,001 to £150,000; and 45 percent if they earn more than £150,000 (relates to England, Scottish Rates are different). 

Keeping your salary just above the threshold of qualifying for a state pension, while keeping within a minimum tax bracket, enables you to get the most benefit from your wage.

As of 2017/18, a director can pay themselves a salary of £8,164 per year (£680.33 per month) and still be able to enjoy state pension entitlement without paying National Insurance Contributions (NIC).

Where remuneration is paid in a cash form (such as a salary, bonus payment), the employee is liable to income tax and Class 1 NICs (12% and/or 2%), unless the taxpayer is not liable to NIC.

The employer company will also be liable for secondary Class 1 NICs (13.8%) on the remuneration paid. Tax and NIC must be deducted at source by the company under PAYE. The salary and any Class 1 NIC liability is also deductible for corporation tax purposes.

If the bonus is not cash, the rules are dependent upon the kind of item it is.

Pension schemes

Paying into a pension can be an efficient way to make the most of your business’s income: in the short-term you can extract profits and in the long-term you are planning for retirement.

An individual can pay up to £40,000 into a pension fund each tax year. This is however reduced for anyone whose annual income exceeds £150,000.

Pension contributions made by the company reduce the business’s overall profit, and thus lower the amount of Corporation Tax due, but there is normally no limit on how much a company can pay into a pension scheme. Whether they get full corporation tax relief would depend upon the Inspector of Taxes and the contribution meeting the “wholly & exclusively” rules.

The first 25 percent withdrawn from a pension pot is tax-free. After this, any withdrawals will be taxed. This will be taxed at your marginal rate at the time. This generally tends to be lower than at the time of paying into the scheme as your income generally decreases when you retire.

Dividend payments

A dividend is a payment that can be paid to anyone who owns shares in a company, providing that company is making enough profit.

A shareholder can receive dividends of up to £5,000 in any tax year (6th April to 5th April) before paying tax. After the first £5,000 any further payments will be taxed. The UK government plans to reduce the tax-free dividend income level to £2,000 from £5,000 per tax year from April 2018.

The rates of income tax on dividends for the 2017/18 tax year are:

Dividend allowance (£5,000) 0%

Basic rate band 7.50%

Higher rate band 32.50%

Additional rate band 38.10%

Taking dividends also removes the employer from an obligation to pay 13.8% secondary NICs. Dividends are not deductible for corporation tax purposes and are not treated as earnings for pension purposes.

As dividends payments are added on top of other income – if a dividend takes someone into the next tax band, it may be taxed at a higher dividend tax rate.

Not only are dividends exempt from National Insurance Contributions, they can be tailored to individual needs, as long as the company can afford to pay them. 

To find out more about dividends go to www. gov.uk.

 

Interest

Some directors also choose to lend money to their company by a simple loan account.

The director/shareholder can then charge interest to the company in this scenario. This can be tax efficient as although the interest received is chargeable to income tax it is not towards earnings for NIC purposes, also enabling NIC-free extraction.

Capital Proceeds

With Capital Gains Tax (CGT) rates set at 10% for basic rate taxpayers and 20% for higher/additional rate taxpayers, taking capital value as a lump sum is also seen as a favourable way of extracting money from the company.

Also, if Entrepreneurs' Relief (ER) is available, the CGT rate is reduced to 10%, regardless of the taxpayer’s taxable income. Entrepreneurs Relief will often become available upon the sale of all/part of your business or sale of shares in your business where you hold at least 5% of the shares and voting rights

In addition, all UK taxpayers have an annual exemption which means that the first £11,300 per annum (2017/18 tax year) of capital gains are not charged to tax. Typically, most taxpayers do not use their CGT exemption

Cash taken out of a company can be treated as capital proceeds for Capital Gains Tax (CGT) purposes if extracted in one three ways: Company Purchase of Own Shares (CPOS); Capital redemption/return of capital; Distributions on winding up of a company.

Please note that this article is not intended to give specific technical advice.  It is designed to alert people looking at tax efficient solutions to some of the issues.

If you would like to find out more about tax efficient profit extraction and how Ethos can help, don't hesitate to get in touch with us on 01302 244977, or visit our website http://www.ethosfs.co.uk

 

*All statements concerning the tax treatment of products and their benefits are based upon our understanding of current tax law and HMRC practices both of which are subject to change in the future. Levels and bases of reliefs from taxation are also subject to change, and are dependent on your individual circumstances.

 

 

Publish date: 19th October 2017

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