Tax efficient methods for extracting cash from your business
Personal Tax Planning
When you’re running a business, it’s important that you reward yourself for all your hard-earned efforts. Working out the best way to pay yourself from your company is a vital part of personal tax planning. There are several options to extract cash and take money as personal income from your business - in this blog I’ll explore these options.
Low salary/high dividends
It is usually advisable to draw a small salary for your work as a director.
By limiting the salary to the National Insurance threshold of £8,840 per year, then neither the company nor you will have to make any National Insurance Contributions, but the company will benefit from a corporation tax deduction.
Furthermore, because the salary is over the ‘lower earnings limit’ of £6,240 per year, you will still qualify for a year's contribution towards your state pension.
Even if you have other income that uses up your personal tax allowance, drawing a low salary is still a tax neutral method of extracting cash from the company.
Once the minimum salary has been taken, income is topped up by way of dividends.
The main advantage of dividend payments is that they are exempt all types of National Insurance Contributions (both for the company and the shareholders). However, dividends are paid out of post-tax profits, so are not eligible for corporation tax relief.
They are also subject to lower tax rate than earnings and other investment income.
The first £2,000 is tax free, and the remainder is taxed at just 7.5% if overall income stays below £50,270.
Dividends can be paid to any shareholders if the business is making sufficient profit to cover these costs.
Pension contributions are an extremely tax efficient way of taking profit out of the company. For the company, the contributions are an allowable business expense saving corporation tax.
Unlike personal pension contributions, which are paid out of income which has already been taxed (and potentially National Insurance), company pension contributions save both income tax and national insurance at source.
However, access to your pension pot is locked until you're 55.
Interest on director loans
If you've loaned money to your company, you can be paid interest on the amount you've loaned, provided the interest rate is commercially justified.
This is an allowable expense for the company, saving corporation tax at 19%.
For the individual there is no National Insurance payable. Income tax is paid at the same rate as for earned income, but there is a personal savings allowance of £1,000 (for basic rate taxpayers) or £500 (for higher rate taxpayers) on which you pay no income tax.
Rent on assets
Another method of extracting tax neutral cash from the company is to charge the company rent for assets owned by you but used by the company.
Usually this is property, such as offices or commercial units, owned personally but from which the company trades.
Again, this is an allowable expense for the company, saving corporation tax at 19%.
For the individual there is no National Insurance payable. Income tax is paid at the same rate as for earned income.
There is a property allowance, which provides a tax-free exemption on the first £1,000 of property income. This allowance is optional and is used instead of actual property expenses. Therefore, if your expenses exceed £1,000, you should claim those instead.
Reimbursement of motoring costs
If you use your own car for business journeys you can claim a tax-free mileage allowance from the company at HMRC’s approved mileage rate.
This is currently 45p per mile for the first 10,000 miles per tax year, and 25p per mile thereafter.
This mileage rate covers all costs of owning and running the car, like depreciation, fuel, and servicing so no additional costs can be claimed. However, parking costs can be claimed.
Instead of using your own car, you may wish to look at the option of the company providing you with a car.
Historically this has not been tax efficient, due to the harsh benefit in kind charges that can arise on employees.
The benefit in kind for cars is calculated by multiplying the list price of the car by a percentage, which is set by reference to the CO2 emissions of the car.
The maximum percentage rate is currently 37% of the list price (on cars with emissions of 165 g/km or higher).
However, the rates for fully electric cars (producing zero CO2 emissions) are currently only 1% of the list price. This rate will rise to 2% next year, but it is still an extremely favorable rate compared to those for higher emitting petrol or diesel cars.
Business owners that want to extract profits from their companies as tax efficiently as possible have several options open to them. With ever changing tax laws, it is worth speaking to your accountant before you make your final decisions on extracting cash from your business to ensure you do it in the most tax efficient way.