Limited company owners: tax-efficient ways of extracting profit

Extracting profit from your company has tax implications for you and the company. As the 50% additional income tax rate applies from 6 April 2010 it is important to know how much tax you will suffer on the profit paid out.

Dividends versus salary/bonus

The decision of whether it is more tax-efficient to take salary or a dividend depends on the income tax and NIC suffered in the hands of the recipient, the NIC charge to the company and the corporation tax relief due on the tax deductible payments.

A dividend is free of NIC both to the individual and to the company, but it is also paid out of after tax profits, so there is no corporation tax relief due on the dividend paid.

Up to 5 April 2010 the higher rate of income tax due on UK dividends is equivalent to 25% of the dividend received. After 5 April 2010, the introduction of the additional 50% income tax rate on income over £150,000 means that dividends taxable at this rate suffer an equivalent rate of tax of 36.1%. In this simple situation, it would be much better to pay a dividend before 6 April 2010 and so avoid the additional income tax charge, even though the date for paying the additional rate tax is brought forward.

The same issue applies to bonuses, in that bringing forward the payment of a bonus before the end of this current tax year will avoid the additional rate tax charge of 50%. There are obviously NIC liabilities to consider, though the increases to both employee and employer rates apply from 6 April 2011.

Salaries and bonuses paid, together with the employer NIC liability, are all deductible for corporation tax purposes, the relief depending on whether the company is liable at the small companies rate or the standard rate.

Loans

Loans to participators (generally owners/controllers) of Close Companies (generally small companies) have two tax implications. The loan itself will incur a 25% tax charge (under s419 ICTA 1988) for the company, but this is repaid when the loan itself is repaid or written off. If the loan, or aggregate loans to the individual, exceeds £5,000, a benefit in kind has been provided, calculated using HMRC's official rate of interest, and Class 1A NIC is payable by the company and the individual suffers tax at the marginal rate of income tax applicable for the tax year. The specific circumstances of the company and the individual need to be considered, but it may be that this is an alternative to a dividend or bonus.

Tax-efficient benefits in kind and reimbursed expenses

The provision of a fuel efficient company car benefits both the company and the individual (see below re company cars).

Where the individual uses their own car for business travel, reimbursement at the HMRC tax-free approved rates is both advantageous to the company and the individual.

The provision of qualifying childcare vouchers and directly contracted childcare has limited income tax and NIC relief. However, from 6 April 2011 new members to qualifying schemes will have their tax relief restricted to the basic rate, though existing members will continue to obtain higher rate tax relief after 6 April 2011. The provision of workplace nurseries will continue to be exempt from income tax and NIC.

Employer pension contributions can be a tax-efficient means of extracting profit from the company and the costs are usually deductible by the employer, and tax and NIC free to the employee. Professional advice should be sought regarding the new legislation on tax relief for pension contributions and the anti-forestalling provisions.