Business owners can get value out of their company in a variety of different ways, but some are more tax efficient than others. Have you explored all your options for tax efficient profit extraction?
Salaries paid to workers are subject to PAYE and NIC, and employees receive only a net payment of cash. Profits from a sole trade or partnership are also subject to Income Tax and NIC on an arising basis (i.e. as profits arise), whether or not the cash is required by the individual concerned.
Business owners that have their own limited company are able to withdraw profits by a number of flexible means. This allows the owner to devise a strategy to extract profits in a tax efficient manner, allowing them to take home more cash for their efforts and unlock personal objectives such as home improvement works to significant holidays.
Most entrepreneurs’ will be aware that a low salary followed by top up dividends will be relatively tax efficient, and this is a strategy that should be considered in most scenarios. However, there are a number of other ways in which profits can be extracted in the right circumstances:
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Pensions – Tax deductible in the company, pension contributions can be extremely tax efficient as they are not subject to tax in the pension, and are only taxed when withdrawn in future. These should be considered in all profit extraction strategies.
- Benefits – There are only a limited number of benefits that remain tax efficient. However, providing a company car with low CO2 emissions can be tax efficient, and Directors can receive “trivial benefits” (broadly non-cash vouchers worth £50 or less) tax free, up to a total of £300 per annum.
- Rent (from individual) – although still subject to Income Tax, rental payments made by a company to an individual are not subject to NIC, but still remain tax deductible for the company. As such, renting a property to your company can be an effective way of extracting profits. However, this can have other negative implications (for example on Entrepreneurs’ Relief) and should not be undertaken without seeking advice.
- Rent (from pension scheme) - Holding a commercial property in a pension scheme and renting it your company can be even more tax efficient compared to renting from an individual, as the rent is tax deductible in the company, but not taxed in the pension scheme.
- Interest – similar to rent, interest on a loan from a Director is subject to Income Tax personally, but not NIC, whilst remaining tax deductible for the company. There is also a personal savings allowances tax free amount for basic and higher rate taxpayers. Charging a market rate of interest on a loan that is in credit (i.e. owed by the company to the individual) can therefore be an effective way of extracting funds.
- Exit / sale events – where the opportunity arises, leaving cash in a company can be a longer-term tax efficient strategy where the business will be sold in the future. By leaving cash in the company, it will be worth more upon sale. Ordinarily, any gains made on sale would be subject to Capital Gains Tax (CGT) at rates of 20%, or 10% if Entrepreneurs’ Relief applies. Compared to the Higher Rate of Income Tax on salary (40%) or dividends (32.5%) this can represent a large saving.
- Family successions - In the case of a family company, rather than gifting the business to the next generation free of charge, in the right circumstances the company could be sold in exchange for cash or a debt, again allowing cash to be extracted from the company at lower CGT rates. This can provide the recipient a lump sum or a kind of “income” to draw down over a number of years.
- Loans – Business owners may be tempted to borrow money from their company, thinking this to be tax free. However, although in some instances borrowing cash from a company can be an effective way of extracting profits, there are some specific tax rules relating to such loans which treat them as a benefit in kind and can lead to temporary tax charges in the company. These are only really effective as a way of extracting profits if there is a sale event on the horizon, where the loan can be cleared tax efficiently at that point.
Here to help
Our dedicated tax planning team helps clients devise strategies to extract cash from their business in a tax efficient manner. In particular, we can provide assistance with determining workers’ employment status, liaising with workers as necessary and supporting the business with the appeals process.
Begin your journey with us today. Drop us a line and let's start talking about how we can save you tax.
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David Robinson
As a Tax Partner, I advise clients on all aspects of UK tax, ranging from business taxes, transactions and private client matters, helping to achieve the objectives and aspirations of businesses and their owners.
View my articlesTags: Business Taxes
