Extracting profit - save on tax

There are numerous ways of extracting profit from your company, each of which has its own implications for the tax you pay, and for the company itself.

Most of the strategies below relate to limited companies. Company cars and vans are discussed in the section How tax-efficient is your company car? 

Corporation tax is 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 can be a difficult one and the issue requires careful consideration. A dividend is paid free of national insurance contributions, which would typically cost 12.8%, whilst salary/ bonuses can carry up to 23.8% in combined employer and employee contributions. However, salary/bonuses are generally tax deductible to the company, whereas dividends are not, so the choice is not always straightforward. Paying a dividend can create a considerable saving; the last date for paying a 2010/11 dividend is 5 April 2011, and any higher rate tax on that dividend will not be due until 31 January 2012.

The top dividend tax rate is now 42.5%, so thought needs to be given as to the timing of dividends if taxable income is likely to exceed £150,000.

Alternative options

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

Capitalisation

For those expecting to liquidate their companies in the next few years, profits might be left in the company to be drawn as capital, as profits not needed for current expenditure could, under current rules, be taxed in the company but subject to  capital gains tax, only, on liquidation - with a tax rate perhaps even as low as 10% if entrepreneurs' relief is available.

Incorporation

As the last couple of points may have suggested, 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 40p a mile for the first 10,000 miles and 25p a mile above this. If you use your motorbike the rate is 24p a mile, and you can even claim 20p a mile for using your bicycle!

Pensions

Employer pension contributions can be a tax-efficient means of extracting profit from your company, as long as an individual's overall remuneration package remains commercially justifiable. The costs are usually deductible to the employer and tax and national insurance-free to the employee.

 Care may be needed if the anti-forestalling provisions will affect you (see above for further details).

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 a rent, which can be anything up to the market value, if you wish. The rent is usually deductible to 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/when you come to sell the property, so care needs to be taken to weigh up the pros and cons.

We can advise you on the most appropriate options for extracting profits from your business. Contact your usual Littlejohn tax adviser for further details or email tax@littlejohnllp.com