Extracting profit – and saving tax

While there are numerous ways of extracting profit from your company, each option has its own implications in terms of the amount of tax you pay, as well as for the company itself.  Here are some key planning strategies for extracting profit and saving tax.

Note that corporation tax is the tax due on a company’s profits, while personal income tax generally applies to what is drawn out of the company by means of a salary, bonus or other form of remuneration.

Dividend versus salary/ bonus

The question of whether it is better to take a salary/bonus or a dividend requires careful consideration. A dividend is paid free of NICs, whilst a salary or bonus can carry up to 25.8% in combined employer and employee contributions. However, a salary or bonus is generally tax deductible to the company, whereas dividends are not. 5 April 2014 is the last date for paying a 2013/14 dividend, and any higher or additional rate tax on that dividend will not be due until 31 January 2015.

Defer income

The top income tax rate is 45% and the equivalent dividend tax rate is now 37.5%, so thought needs to be given to the timing of bonuses and/or dividends if taxable income is likely to exceed £150,000, especially if income in 2014/15 will be less.

More ways to extract profit

You may also want to consider alternative means of extracting profit, which might include the following:

Capitalisation
For those expecting to liquidate their company in the next few years, profits might be left in the company to be eventually drawn as capital.
Current rules allow retained profits distributed on liquidation to be subject to capital gains tax, with a potential tax rate as low as 10% if Entrepreneurs’ Relief is available. However, caution is advised as high cash reserves held without a clear business purpose or substantial investments can potentially jeopardise Entrepreneurs’ Relief or IHT Business Property Relief.

Incorporation
As the above points suggest, incorporation may give more scope for saving or deferring tax than operating as a self-employed person or partner.
Of course, incorporation may not suit all circumstances, and the ‘IR35’ rules specifically counter the use of ‘personal service companies’ to reduce tax, but we will be pleased to discuss how incorporation might apply to you and your business.

Tax-free allowances
Tax-free allowances, such as mileage payments, apply when you drive your own car or van on business journeys. The statutory rates are 45p per mile for the first 10,000 miles and 25p per mile above this. If you use your motorbike the rate is 24p per mile, and you can even claim 20p per mile for using your bicycle!

Childcare
Parents of young children may be entitled to tax and NIC-free childcare vouchers of up to £55 per week, provided by their employer. Where both parents are employees, of the same or different employers, the exemption is effectively doubled. The costs are usually deductible to the employer.
Maximum vouchers per parent: For people who joined the scheme before 6 April 2011, the limit is £55 per week. For those joining now, or who joined on or after 6 April 2011, the limit is:
– If your top tax rate is 20% – £55 per week
– If your top tax rate is 40% – £28 per week
– If your top tax rate is 45% – £25 per week.
By using the available allowances and exemptions your family could maximise tax-free income and gains – please contact us for advice.

Pensions
Employer pension contributions can be a tax-efficient means of extracting profit from a company, as long as the overall remuneration package remains commercially justifiable. The costs are usually deductible to the employer and free of tax and NICs for the employee.

Property
Where property which is owned by you is used by the company for business purposes, such as an office building or car park, you are entitled to receive rent, which can be anything up to the market value, if you wish. The rent is usually deductible for the employer. You must declare this on your Tax Return and pay income tax, but a range of costs connected with the property can be offset. On the other hand, receiving rent may mean a bigger capital gains tax bill if or when you decide to sell the property, so care needs to be taken to weigh up the pros and cons.
Naturally, you can talk to us about the most tax-efficient ways to extract profits from your business.