Taxation has been woven into the fabric of our society since the first city states flourished in Ancient Sumer. Whilst salaried workers can often do nothing about their tax liabilities, business owners can exercise choice in the way they extract wealth to minimise their tax liabilities.
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Director's loan
A director could use a loan to extract wealth from the business and either repay it in full or may be able to use multiple loans & repayments to build up a balance over time without tax. However, if its not done correctly 25% of tax may be due on the outstanding loan balance. Also, if the director's loan is written off, it'll be taxable as dividend income and is likely to attract class 1 NI, so isn't very efficient to write off.
Salary vs dividends
Salary costs more in tax than using dividends, mainly as dividends don't involve national insurance contributions. This is true at all levels, but especially between the £30k - £50k profit level for proportion of profits spent on tax.
It may also be possible to use different share classes to pay dividends in different ratios to the actual shareholdings. Although need to consider if shares will need voting/capital rights, e.g. to shift income to spouse.
To get the full tax benefits for either salary or dividends there are a number of key points to note. These include paying salary within 9 months of the year end and ensuring adequate paperwork is in place to support the salary. Dividends require a sufficient level of profits to avoid being illegal and require board resolution and minutes.
Salary and dividend strategies should be reviewed prior to the company's year end and also before the tax year end of 5 April, to perform tax planning and to get the right paperwork in place in time.
Management fees / overseas
Rather than using wages or dividends it may possible for the owners to charge management fees to another loss making UK company.
If the owners are domiciled overseas they may also be able to shift income by paying management fees to an overseas company in a low tax jurisdiction.
Care needs to be taken to ensure the fees are justifiable and that any overseas company is managed and controlled overseas and be able to provide HMRC with supporting evidence such as email/call logs & passport stamps.
Capital route
Rather than extracting too much wealth in the short term, the profits could be re-invested in the business with the aim of increasing its value in the long term to make a bigger profit on exit. Capital gains tax of 10% would be lower than either salary or dividends for the first £10m of capital gains in a lifetime if the criteria for Entrepreneurs Relief are met. It also needs a genuine disposal transaction with a commercial justification.
Other points
A director could also use benefits such as medical insurance or company cars to extract wealth. This could potentially save on employee's NI compared to salary, but need to check the calculations for the tax efficiency of a particular benefit due to differences in how they're calculated.
Pensions are a complicated area and there are many other investment considerations, but from a tax perspective, pensions are highly tax efficient as a director could obtain tax relief at the full marginal rate on contributions up to £50k.
The above discussion has simplified things to enable comparisons. However, it should be noted that profit is not the same as cash and a company could make lots of profit but be cash poor. So a company should keep sufficient cash in the business to fulfil its working capital requirements and a contingency should also be kept for a "rainy day".
Disclaimer
The above is not intended to constitute legal, financial, tax or other advice, and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. We shall accept no responsibility for any errors, omissions or misleading statements in the above, or for any loss which may arise from reliance on materials contained in the above.
Mohammed is a business advisor and tax expert who has worked with everyone from startups to AIM Listed plcs to multinational £150m+ businesses in a variety of sectors from manufacturing to online gaming.
MAH, Chartered Accountants focus on providing a quality service that not only achieves compliance with financial laws and regulations, but also explores opportunities for growth, tax savings and keeping the business healthy.
Visit our website http://www.mah.uk.com/ for full details and a 2,500 word pdf with graphs that expands upon the summary outlined mentioned below.
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