UPDATED: Navigating your way through the early stages of your company life cycle can be one of the most challenging times for small businesses.
From knowing when it’s time to recruit to choosing suitable office space, there are a number of pitfalls awaiting companies who aren’t prepared for what’s ahead – and financial instability can be one of the deadliest snares when it comes to staying afloat.
In this post, the private investment experts at Current Capital break down a selection of tactics business owners can use to extract profit from their business, while keeping one eye on your taxes at all times.
When it comes to saving for retirement, you could see some immediate benefit from pension contributions – as this is one way to extract profit from your company while still benefiting from tax relief. Whether it’s an individual or the company itself who pays into the pension fund, this money isn’t treated as a benefit, meaning that it’s very tax efficient.
£40,000 is the limit for individuals on what can be paid into a pension each tax year, but this is reduced for any person with an annual income which exceeds £150,000. Personal pension contributions are restricted to no more than 100 per cent of an individual’s relevant earnings, meaning they need to be carefully considered when using some of the other strategies in this article.
Any pension contributions made by the company (rather than the individual) reduce the business’s overall profit, meaning the amount of corporation tax is also reduced. Unlike personal contributions, there is no limit on how much a company can pay into a pension scheme.
When withdrawing from your pension pot, the first 25 per cent is tax-free. After this, any withdrawals will be taxed at your tax rate at the time, which is generally lower than at the time of paying into the scheme.
Both a short-term way of extracting profit and a long-term way of planning for retirement, paying into a pension is a great way to make the most of your business’s income.
Dividends can be paid to anyone who owns shares in a company, as long as the company is making sufficient profit to cover these costs. Starting in the new tax year this April, a shareholder can receive up to £2,000 in any tax year (6th April to 5th April) before paying tax – after this, any further payments will be taxed based on the tax bands below.
Remember, dividends are added on top of other income. So, if a dividend takes someone into the next tax band, it may be the case that the dividend is taxed (partially, perhaps) at a higher dividend tax rate.
The tax advantages of being paid dividends are twofold: firstly, they’re exempt from National Insurance Contributions and secondly, they’re discretionary. This means they can be tailored to individual needs, subject to the company being able to afford to pay them. When issued, all dividend payments should be accurately recorded, with a tax notification issued.
Find out more about dividends at gov.uk.
Salary and bonuses
In order to achieve maximum tax efficiency, it’s wise for directors to take a minimum salary. For directors, the first £11,850 is income tax-free. From there, you’ll pay 20 per cent on any salary up to £46,350, 40 per cent on any salary up to £150,000, and an eye-watering 45 per cent on any salary that exceeds this.
By keeping your salary just above the threshold of qualifying for a state pension, while keeping within a minimum tax bracket, you can get the most benefit from your wage.
One of the most obvious and appealing ways to extract profit from your company is to pay yourself a bonus. In terms of benefits, this will largely depend on whether you’re receiving a cash or non-cash bonus.
If your bonus is paid in cash or anything that can be exchanged for cash (like vouchers), this will be counted as earnings and will be subject to both PAYE and employee and employer NICs. For non-cash bonuses, the amount of tax will be dependent on the item in question.
Find out more about non-cash bonuses at gov.uk.
Private investments are a chance to commit your money to another business, helping early-stage companies to reach their next stage of growth. With opportunities to invest your money in a private company that interests you both personally and professionally, you can invest your profits into the right business for you.
Investing in a private company means you can be involved from the early stages of a company’s life and make a tangible difference to its development. With the potential for EIS or SEIS eligibility, you may also be able to reap the rewards of great tax.
With your tax-efficient investments in good hands, you may even be able to decide on the amount of involvement you’d like with your investment and how often you’d like to receive updates. This means that you’re completely in the loop when it comes to where your investment’s being spent.
For companies looking to explore their profit extraction options and reduce their tax bill, these avenues will help get you started.
This one is more temporary than the other options, but can be a method of extracting money nonetheless.
Director’s loans are better known for helping directors pay off unexpected bills or costs. They are admin-heavy, can cause concern from shareholders and run the risk of hefty tax penalties if paid late (after nine months and one day).
However, they can work the other way round, too: you can loan the company in return for interest. Any interest paid is treated as income and must be stated on your self-assessment tax return.
It is always best to speak to an accountant before heading down this path, though. More information on director’s loans can also be found on the gov.uk site.