Extracting profit - the tax-efficient way

While there are numerous ways of extracting profit from your company, each has its own implications for the amount of 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 article Company cars - a tax-efficient option? in this guide.

Corporation tax is the tax 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 or 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, whilst a salary or bonuses can carry up to 25.8% in combined employer and employee contributions. However, a salary or bonus is 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; 5 April 2012 is the last date for paying a 2011/12 dividend, and any higher rate tax on that dividend will not be due until 31 January 2013.

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.

Some alternatives

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

Capitalisation

For those expecting to liquidate or sell their companies in the next few years, profits might be left in the company to be ultimately withdrawn as capital.

Current rules allow retained profits distributed on liquidation to be subject to capital gains tax, with a potential tax rate as low as 10% if entrepreneurs' relief is available.

Incorporation

As the above points may suggest, 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 45p 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!

Childcare

Parents of young children may be entitled to tax and national insurance-free childcare vouchers, including the provision of vouchers of up to £55 a week, provided by their employer. Where both parents are employees, of the same or different employers, the exemption is effectively doubled. The costs are usually deductible to the employer.

Maximum vouchers per parent:For people who joined the scheme before 6 April 2011, the limit is £55 per week.

For those joining on or after 6 April 2011, the limit is:

• if your top tax rate is 20% - £55 per week
• if your top tax rate is 40% - £28 per week
• if your top tax rate is 50% - £22 per week

(Your children also have their own personal allowances, capital gains tax (CGT) exemptions and tax rate bands, so depending on your circumstances, it may be possible to take advantage of these allowances to help maximise family income and wealth

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. See Planning for your 'golden years' for more details on the latest pension rules.

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 rent, which can be anything up to the market value. 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.

Under Rent-a-room, individuals can be exempt from income tax on rent received from providing furnished accommodation in their own home, if the gross receipts are £4,250 or less.

On the other hand, receiving rent may mean a bigger CGT bill if/when you come to sell the property, so care needs to be taken to weigh up the pros and cons.

Please contact your usual Littlejohn tax adviser or email tax@littlejohnllp.com to discuss the best ways to extract profits from your business tax-efficiently.