Tax-efficient ways of extracting profit

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 Reducing the Cost of Business Motoring on page 9.

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 13.8%, 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. 5 April 2010 is the last date for paying a 2009/10 dividend, and any higher rate tax on that dividend will not be due until 31 January 2011. For those whose income could exceed £150,000 in 2010/11, thus attracting the new 42.5% rate of tax on dividend income, thought needs to be given to accelerating dividends into 2009/10.

Alternative options

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

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!

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. Whether both parents are employees of the same or different employers, the exemption is effectively doubled. The costs are usually deductible to the employer. (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.

Care may be needed if the anti-forestalling provisions will affect you (see below 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.