It’s always advisable to seek advice from an accountant when formulating personal and corporate tax planning strategies. As financial planners, we often work alongside accountants on behalf of our clients as both services are very closely aligned.
There are 4 main ways to extract profits from a limited company. In this article, we will focus on the tax position of the owner/director as opposed to the business itself but, briefly, a limited company incurs two main types of tax:
- Corporation Tax – currently 19% is a tax on profits, once business expenses such as salaries, National Insurance and Pension contributions have been deducted from turnover.
- National Insurance – the most common rate for a company to pay is 13.8% when employees salaries exceed £702 per month. It is only earnings over £702 per month that attract an NI payment of 13.8%.
The four ways to extract profits from a limited company
This will be taxed as per any employee. UK taxpayers have a personal allowance which is currently £11,850 p.a. The personal allowance reduces for those with net adjusted income over £100,000.
National Insurance is also payable once an individual’s salary exceeds certain thresholds. There are other rates and bandings of NI but most employees pay ‘Class 1, Category A’ contributions which are 12% of salary over £702 per month and 2% over £3,863 a month.
Both Income tax and NI are factors to consider when extracting profits via a salary payment as these will reduce the net amount which hits your bank account.
Many company directors chose to be paid at least enough salary to earn a qualifying year towards the State Pension, which can be achieved by paying over £162 per week (£702 per month).
Dividend payments are made from company profits and paid to shareholders. Dividends from privately owned companies are taxed in the same way as dividends from investment funds such as unit trusts and Open-Ended Investment Companies (OEICs).
The bandings for dividends are the same as salary income, the only difference is the rate of tax that applies. An individual also has a ‘dividend allowance’ of £2000 where dividends that fall in this banding are taxed at 0%. Any dividend income over the £2,000 allowance will be taxed in the band they fall within.
Which is the most tax efficient? Simple answer is to make pension contributions.
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3) Pension Contributions
Pension contributions are (usually) an allowable business expense which means they do not attract corporation tax or NI, which are two important tax savings for the company.
When an individual takes income from a pension, usually 25% is tax free with the remainder taxed at marginal rates with no NI to pay.
Unlike personal pension contributions, company contributions on behalf of an employee are not restricted to 100% of earned income (salary). This means a company can make a large lump sum contribution to an employee’s pension (currently up to £160,000).
However, whilst highly tax efficient, making a pension contribution to fund immediate income needs is not always a practical solution. To begin with, an individual must be at least age 55 to access their pension (other than in very exceptional circumstances, such as serious ill-health). Also, not all pension providers can facilitate flexible income payments and once income is taken ‘flexibly’ from a pension, an individual is only allowed to contribute £4,000 per annum forevermore.
Typically, company pension contributions are ideal for funding for the future but not always immediate Income needs.
4) Sell the company
Another option is to leave profit in the business and sell the company. If HMRC deem the company to be a bona fide ‘trading’ company, then shareholders could receive Entrepreneurs Relief and pay 10% tax on the sale of the shares. However, any remaining profit within the company will have already been subject to corporation tax.
Many business owners view their business as their ‘pension’ but it is vital to consider how easy the business will be to sell, and will the sale generate the capital necessary to fund a comfortable retirement? In this scenario, an individual’s eggs are well and truly in one basket! Contributing to a pension or having other savings and investments can add diversity and help to mitigate this risk.
Furthermore, a shareholding in a business could potentially be available to creditors if an individual experienced significant financial difficulty, whereas a pension is not.
If you wish to explore whether you can save tax, contact us.
This article is distributed for information purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Ermin Fosse and does not represent a recommendation of any particular security, strategy or investment product. The information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
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