How to take tax-free profits from your Limited Company
If you run a busy and successful limited company, then you may be wondering how you can extract some of your hard-earned money in the most tax-efficient way.
You probably already realise that taking income in the form of a salary is a very inefficient way of getting money out of your business and luckily there are other very useful methods to employ instead.
With this in mind, we have produced a guide that looks at some of the strategies to mitigate the tax you pay and to give you some flexibility over your wealth extraction methods.
Please note though, all of our suggestions should be talked through with a tax advisor to make sure that they are right for you and your business. If you would like to have an initial chat then why not contact us to set up a call?
The most obvious and widely used way owners and directors can pay themselves is through a salary.
This is not the most efficient method however as Income tax and National Insurance Contributions (NICs) are paid on any money taken over the personal tax allowance and of course, the company will be required to pay employers NIC.
There are some good reasons for taking an income in salary though.
For example, PAYE employees who pay NICs also build up credits that go towards the state pension and maternity benefits and it is possible that free NHS care and benefits may start to be increasingly linked to your NIC record in the future.
Salary payments are a legitimate business expense which means that the company pays no Corporation tax on the amount paid.
Taking a small basic salary will also use up your annual allowance so that no tax will be paid on the first tranche of income (currently £12,500pa).
If you want to make personal pension contributions, then you will need to have a qualifying salary and when applying for mortgages and loans you will also need to show that you have a regular income.
For these reasons we often suggest that our business owner clients take a reasonable salary level even if it is slightly less efficient overall.
Many of our clients who own limited companies take a blended income that is made up of salary and dividends.
Generally, a salary will be paid monthly, and the company will declare a dividend annually or more frequently that then tops up the director’s income.
Taking a dividend has the big advantage that it is taxed at a lower rate than a PAYE salary and no NICs are payable by either company or employee but you will need to include the amounts on your self-assessment return.
Dividend tax rates
Individuals also have a £2,000 annual dividend allowance that means the first tranche of income is tax-free. There are some drawbacks with taking your income in the form of dividends though.
Firstly, you can only take a dividend if the company has enough profit to cover it (known as distributable profit) and if you don’t have enough you will, in effect be taking out a director’s loan.
Dividends are not included when working out the company’s corporation tax which means that the business will essentially be paying tax on the dividend.
And dividends are not an allowable form of income when assessing your pension contributions which means that the amount you can put away for your retirement may be reduced.
Putting money into a pension is always a good idea and we always encourage our clients to set up a policy as soon as they feel able. But apart from being a smart move in terms of retirement planning, it is also an exceptionally useful way of extracting wealth from your business.
Direct contributions from your business into a pension fund are not classed as income and so no tax or NIC is payable and they are also an allowable expense for the company which means that they reduce the corporation tax payable.
Your company has a generous annual allowance of up to £40,000 at the time of writing which means that even if you only take a small salary you can still make healthy pension contributions.
Pensions are, generally speaking, a very good way of investing money for the future as the pension funds themselves benefit from generous tax-breaks which increases the average return.
There is an obvious drawback to taking a pension though – most people cannot access their money until they are 55 which means that the money is locked away.
However, on retirement, you can take a good chunk of the fund as a tax-free lump sum which is useful for paying off a mortgage or any loans you have.
Another way to take wealth from your company is in the form of staff benefits. For example, it is possible for the company to provide death-in-service life cover for its employees and this is a tax-free benefit.
Your company could also run schemes such as a Bike2work benefit that gives employees a tax-free loan to buy a bike and initiatives like this pop up all the time so it is worth keeping an eye out for tax-efficient benefits you can provide. But you do need to beware.
Staff benefits have quite convoluted rules and if you structure these in the wrong way, they can end up costing you money.
For example, company cars have a Benefit In Kind (BIK) regime that means that employees who are provided with a company car will have to pay tax on the value of the benefit.
For the 20/21 tax year, electric cars have no BIK value (meaning they are essentially tax-free) but this increases for subsequent years.
So, our advice to you is that if you are thinking of giving yourself benefits then chat through all the options with us first!
If you do not need the money now, then there is always the option of leaving the cash in your business or using it to expand.
When you come to sell the company, its value will consequently be much higher, and you will receive a much better sale price. Tax will be payable on the sale price but by utilising your entrepreneurs’ relief lifetime allowance of £1 million, you can reduce the capital gains tax rate to 10%.
For business owners who are relatively close to a sale date, it may make sense to leave the money invested in the company and then use as much of the entrepreneurs’ relief allowance as they can.
Should something happen in the meantime you still have the option of releasing cash from your company as it is not locked up.
Spouse and children
If you want to give gifts to your spouse or children, then it is possible to restructure your shareholding so that they can benefit from the annual dividend allowance.
This means that they will receive up to £2,000 per year, tax-free in the same way as the main shareholder does.
Again, this can only be paid from distributable profits, but it is a way of making sure that your offspring get a little something and you do not end up paying the tax.
Please do take advice before restructuring your company in this way as there are complex rules that need to be followed to make it tax efficient.
Admittedly, this is not a way of receiving income for yourself but more a way of efficiently giving cash to causes you care about.
Companies are entitled to tax relief on donations to registered charities and this is an excellent way of supporting worthy causes.
Rather than paying over money to a charity that has been subject to two lots of NIC and income tax, it is often better to simply give direct.
Interest and rental
If you allow your company to use an asset that you own, then you can charge the business a fair rate of rental for that asset.
By the same token, if you lend money to the business, then you can charge a market rate of interest.
In both cases, these will be allowable business expenses and so will reduce the corporation tax bill but you will need to declare the income on your self-assessment return and you may be required to pay income tax.
Although the tax is payable there is no employer’s or employee’s NIC on the payments which makes it more efficient.
Royalties and licence fees
If you personally own some intellectual property that the business uses, then you can always charge the company for the use of the asset.
The rules are the same as for physical assets in that no NIC is payable, but the recipient of the income may have to pay tax through the self-assessment process.
If you have an asset that the company can use, then it is possible to sell it to the business.
Again, no NICs will be payable on the value of the sale but from a personal point of view there may be capital gains or income tax payable and so you should take advice before transferring ownership.
Summary: Wealth extraction strategies
There are several different methods that you can use to reduce your overall tax and NIC bill.
We have also seen that there are good reasons for continuing to use the less efficient PAYE method of drawing a salary and that for most people it makes sense to keep paying themselves a small amount in this way. The rules around company directors and tax change all the time so the main message must be that before choosing any of these strategies you should really talk to a qualified tax advisor.
We’re happy to have a chat and show you how we can help you decide on the best way forward for your particular situation so why not schedule a call