A low salary combined with dividends had long been the most tax-efficient salary option for limited company contractors, freelancers and owner-managed businesses, due to the fact they are exempt from National Insurance Contributions and they are discretionary, meaning they can be tailored to individual needs.
However, when Finance (no.2) Bill 2017 was published, small business owners saw their dividend tax-free allowance cut by 60%, from £5,000 to £2,000 per annum, the equivalent of £225, £975 or £1,143 per annum depending on whether you are a basic rate, higher rate or additional rate taxpayer.
With small businesses liable to corporation tax, national insurance and PAYE, we look at the most tax-efficient ways to extract profit from your business.
Whether you’re an individual or a company paying into a pension scheme, the money contributed isn’t treated as a benefit making it very tax efficient.
As a company, any pension contributions made do not suffer corporation tax or national insurance. There is also no limit on how much a company can pay into a pension scheme, meaning any payments made will be deducted from the business’s overall profit, thus reducing the amount of corporation tax that is due*.
When withdrawing from your pension pot, the first 25% is tax free with the remainder taxed at marginal rates (which are generally lower than at the time of paying into the scheme) with no NI to pay. Pension contributions therefore act as a great short-term method of extracting profits at the same time as planning for your retirement.
One of the main attractions of dividends was the additional tax-free allowance they provided on top of the standard personal allowance. However, since the allowance was cut, individuals can now only earn £14,500 tax free (£2,000 in dividends plus £12,500 personal allowance) down from £16,500 as it was in the 2017-18 financial year.
Therefore, to achieve maximum tax-efficiency, one option is for directors to take a minimum salary, just above the threshold of qualifying for a state pension, and combine this with dividend payments and bonuses.
Whilst cash bonuses are still treated the same way as your annual salary when it comes to taxation, directors can use something called bonus sacrifice to help reduce their tax liability. By sacrificing some of their bonus and instead paying it into a pension scheme, the amount sacrificed is not liable to tax.
There are a variety of non-cash benefits too, including cycle to work schemes, childcare vouchers and computer/smartphone provision.
Private investments provide an opportunity for business owners to invest some of their profits into other growing businesses. Vehicles such as the Enterprise Investment Scheme (EIS) offer a variety of tax reliefs to investors who invest in smaller, unquoted, trading companies, as well as the opportunity to make a tangible difference to a company’s development. There is also the Seed Enterprise Investment Scheme (SEIS), a scheme like EIS but for start-ups. Both offer great tax-efficient advantages including no capital gains tax on any profits you receive and up to 50% tax relief on any investments you make.
If you would like to discuss how to extract profit from your small business, please contact your Finura adviser today.
*Employer contributions are not restricted, however they must satisfy the ‘wholly and exclusively’ requirement to receive tax relief. For more information, visit the HMRC website.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
The investments mentioned in this article are high risk, investments can go down as well as up, They might not be liquid and readily accessible, should you need to sell them. Past performance is not a guide to future performance and may not be repeated. Capital is at risk; investments and the income from them can fall as well as rise and investors may not get back the amounts originally invested.
Articles on this website are offered only for general information and educational purposes. They are not offered as, and do not constitute, financial advice. You should not act or rely on any information contained in this website without first seeking advice from a professional.
The Financial Conduct Authority does not regulate tax or trust advice.
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