Our simplified guide to tax efficient extraction of money from your company, part of a new series on Tax Made Simple
One of the most important aspects of our work at Schoolgate is helping our clients get the most out of their business as possible, financially speaking, when it comes to paying tax. It is almost inevitable that the idea of ‘tax avoidance’ stirs up uncomfortable emotions for most business owners, particularly with high profile imbroglios such as the Paradise Papers making regular appearances in the media. However, at Schoolgate, we believe that not only is it important to be fully aware of the limitations of your tax obligations, but it is even irresponsible as a business owner to pay more than you have to by law if you approach these obligations in an ethical and common-sense manner, as we encourage all our clients to do.
As a result, we have decided to begin a new series, Tax Made Simple, for business owners to provide a concise and understandable guide to what you should pay and how to save money on your tax bill without registering a legal entity in Bermuda.
Our first instalment will cover a general overview of profit extraction strategies, i.e. how to take money out of your company in the most tax-efficient way.
The most common ways of taking money out of a company are via salary payments and dividends. Most people are familiar with the way salaries are taxed, with a personal allowance which is tax free (£12,500) and various thresholds which are taxed at different rates (20% beyond personal allowance; 40% on earnings above £50,000*).
Dividends are sums taken out of the reserve profits of the company. Until April, you could earn £5,000 in dividends tax-free. Unfortunately for business owners, this has dropped to £2,000 for 2018-19 and continues at this rate for 2019-20.
A fairly common tax planning strategy is to take a low basic salary, below the personal allowance amount, so that it does not attract income tax, but high enough so that you are paying National Insurance and are therefore entitled to the benefits this entails. You then make up the balance with income from dividends, which are not subject to National Insurance. However, unlike salaries, dividends are not tax-deductable. This means that the more money you take from the company as a salary, the less corporation tax you have to pay on the profits, but this is not true of a dividend. On the flip side, since you have already paid corporation tax on the company profits, the taxes on dividends are lower than those on salaries (only 7.5% if your overall income is below the £50,000 threshold, and 32.5% if above). As a result, there is a balance between how much to take as salary and how much as a dividend (bearing in mind taxes and National Insurance payable overall).
* Please note rates differ in Scotland
Pension payments are subject to tax relief, which means that qualifying taxpayers can get relief (i.e. a reduction on the amount of tax owed) on private pension contributions worth up to 100% of their annual earnings (subject to the overriding limits). This means that you can pay an amount up to 100% of your main job earnings, i.e. gross salary including any bonuses, profit-related pay and taxable benefits. It does not include other forms of income like dividends.
The annual allowance (limit) for tax relief on pensions is £40,000 for the current tax year. You can also carry forward any unused annual allowance from the last three tax years if you have made pension savings in those years. Be aware, however, that if you take money out of your pension pot, you may have to pay tax on contributions over a much lower figure of £4,000. There is also a lifetime limit for tax relief on pension contributions, which currently stands at £1.03 million.
Tax relief is paid on pension contributions at the highest rate of Income Tax you pay.
This means that:
This means that if you are a basic rate taxpayer and you pay £8,000 into your pension, HMRC adds £2,000 to your pension; if you pay £32,000 in, HMRC will add £8,000 (an easy way to work this out is to take the contribution and divide by 0.8).
Higher rate taxpayers can pay £24,000 to make up their £40,000 contribution (divide by 0.6) and additional rate taxpayers £22,000 (divide by 0.55).
The first 20% of tax relief is usually automatically applied by your employer with no further action required by a basic-rate taxpayer. Higher rate and additional rate taxpayers can claim back any further reliefs on their self-assessment tax return.
The above applies for claiming tax relief in England, Wales or Northern Ireland. There are some interesting regional differences if the taxpayer is based in Scotland. If a Scottish taxpayer is paying Income Tax at the starter rate of 19% they will get tax relief of 20% and are not required to pay back the difference. As with the rest of the UK, basic rate taxpayers in Scotland will pay 20% Income Tax and get 20% pension tax relief. There are also three higher rates, an intermediate rate of 21%, a higher rate of 41% and an additional rate of 46% where further tax relief can be claimed.
Equally, if the company pays any pension contributions, this reduces the overall profits and subsequently decreases the overall amount of corporation tax the company has to pay, making it an effective way of saving tax as well as being an important tax-free benefit to employees.
Although the government is continually clamping down on non-taxable payment and benefits for employees, there remains an eclectic list of expenses that are tax exempt.
Some of the non-taxable benefits include the following:
There is no requirement for employees to pay tax on benefits and expenses covered by concessions or exemptions, and there is also no need for them to be included on your tax return.
If you would like any further information about the information contained in this article, please get in touch to arrange a free no-obligation consultation.
Source: Schoolgate Accounting Services | 30-4-18 (updated 14-8-18, 9-7-19, 30-10-19)