People run businesses for a variety of reasons, but making a living is high up the list for most people. So how do you go about drawing profit from your business in a tax efficient way?
Watch our video to learn more.
If your business operates as a partnership or sole trader, you are taxed on the profits it makes, adjusted for any expenses which aren’t tax deductible.
It makes no difference to your tax bill whether the profits are held in the business or extracted for your personal use.
When you work through a limited company, the total tax paid by the company and the shareholders will depend on the methods used to extract profits, and the amount withdrawn.
The tax rates and thresholds used in the following examples apply to the two thousand and eighteen/nineteen tax year.
Paying yourself a salary
Paying yourself an annual salary of between six thousand and thirty two pounds and eight thousand four hundred and twenty four pounds counts towards the state pension and other state benefits, but neither you or your company have to pay any national insurance contributions (NICs).
Any salary above eight thousand four hundred and twenty four pounds would result in employer’s NICs being payable at thirteen point eight percent.
Employees’ NICs would also be payable above this amount at twelve percent up to a limit of forty six thousand three hundred and eighty four pounds. Above this threshold the rate of employees’ NICs payable falls to two percent.
Your employer’s NICs liability can be set against the three thousand pounds employment allowance, if your company employs more than just you as the sole director and pays each of those additional employees more than eight thousand four hundred and twenty four pounds.
Employing a family member
This can be a good way to spread the income from the business around the family, and use all available personal allowances and lower rate tax bands.
However, the wage paid to a family member must represent a market rate for the work performed – for example you shouldn’t pay your son a senior executive’s salary if he’s working on reception.
Paying Dividends
The company must have sufficient reserves before the directors authorise a dividend to be paid.
If there are insufficient reserves available, any dividends paid may be re-categorised as loans to the recipients.
Each individual is entitled to an annual tax free dividend allowance of two thousand pounds.
Dividends received above this limit are taxed according to the tax band the income falls into:
These tax bands can be expanded if you make pension contributions or gift aid donations out of net income.
Spreading dividend income among your family members can allow them to use their two thousand pounds tax free dividend allowance. However, those family members need to first hold shares in the business which entitles them to receive the dividends.
Dividend income is taxed at the following rates
For Basic-rate taxpayers the rate is seven and a half percent
For Higher-rate taxpayers it is thirty two and a half percent and
Additional-rate taxpayers pay tax at thirty eight point one percent.
You can give away shares to your spouse or civil partner with minimal tax implications, but do seek advice before doing this.
To be effective for tax planning purposes the shares should carry a full quota of rights, including the right to vote, receive a variable dividend and share in the capital of the business on a winding up.
Shares given to employees can be subject to income tax as employment-related securities, but there’s a general exemption from that legislation for gifts made as part of a family relationship.
As an alternative to giving shares, family members could subscribe directly for new shares to be issued by the business.
Pension contributions
Where the business pays pension contributions as your employer, those payments are tax deductible for the business, so long as your total remuneration package is reasonable for the work you perform for the company.
Where the total pension contributions paid by you or on your behalf lie within your annual allowance, usually forty thousand pounds a year, there is no tax charge when the contributions are paid.
If you’ve already taken some pension benefits, or your annual income is one hundred and fifty thousand pounds or more, you may have a restricted annual allowance.
Seek expert advice before investing in a pension scheme.
Benefits-in-kind
You can take advantage of tax-free benefits up to the following limits:
- non-cash gifts up to fifty pounds per item
- one mobile phone per employee
- loans worth up to ten thousand pounds per person and
- employer-provided training on which there is no monetary limit.
The non-cash gifts can be items such as wine, flowers, chocolates, vouchers or a gift card, but it must not be given as a reward for services or be in any way contractual. Vouchers and gift cards must not be exchangeable for cash.
Company directors and their family members can receive up to three hundred pounds of tax-free gifts from the company in total per tax year.
Loans from the company
You can borrow money from your company, if this is permitted by the company’s articles and by company law, but there are tax implications to consider.
Where the loan exceeds ten thousand pounds at any point in the tax year, you will be taxed on deemed interest calculated at three percent of the total loan, less any interest you actually pay. The company will also pay thirteen point eight percent NICs on that net deemed interest.
A loan of any value will generate a corporation tax charge at thirty two point five percent on any amount still outstanding more than nine months after the end of the accounting period in which the loan was advanced.
This tax is payable by the company, but it can be reclaimed once the loan is repaid subject to certain rules.
Where the loan repayments are made out of taxed income, the loan is not treated as a continuous loan.
Be aware that loans to an employee through a third party, such as an employment trust, may be categorised as disguised remuneration and be subject to PAYE and NICs as if the loan was salary.
Lending to the company
If your company owes you money, perhaps as undrawn dividends or salary, it can pay you interest on those funds at a commercial rate. Such interest is tax deductible for the company, if it uses the funds for business purposes.
You should draw up an agreement between yourself and the company to formalise the payment of interest, which sets the interest rate and terms for the loan repayment.
The downside is the company must deduct twenty percent tax from the regular interest payments, and report and pay those deductions to HMRC on form CT61 each quarter.
Where the total interest you receive in a year is less than your saving allowance of one thousand pounds (or five hundred pounds for higher-paid individuals), you can reclaim the tax deducted through your tax return.
If your annual income exceeds one hundred and fifty thousand pounds you are not entitled to a savings allowance.
In addition to the savings allowance, there’s the starting savings rate which owner-managed businesses can take advantage of. In the two thousand and eighteen/nineteen tax year this allows another five thousand pounds of tax free interest if you earn less than eleven thousand eight hundred and fifty pounds.
Rent
If you own a property which is used by the company for its trade, the company can pay you rent. The property can be anything from a factory to part of your own home and in every case, the terms of the arrangement should be set out in a lease or licence agreement.
Always seek legal advice on land-related agreements, and be careful not to give the company exclusive use of any part of your home, as this could restrict your capital gains tax exemption relating to that property.
The rent paid is tax-deductible for the company, and it does not attract NICs for you or the company.
You need to declare the rent on your tax return alongside any relevant expenses, such as insurance or mortgage interest. The one thousand pound property income allowance cannot be set against rent received from your own company.
In the long-term, receiving rent for a commercial property can restrict the availability of entrepreneurs’ relief on gains made on the eventual sale of that property.
We hope you found that useful. If you have any questions please get in touch with us at Jon Davies Accountants.