A fundamental question for most corporate owner managers is how to most efficiently extract profits from their company, especially in light of the frequently changing rules and tax rates / thresholds.
It remains important to regularly evaluate your personal position, as there is no one-size-fits-all approach to profit extraction, and the best route will depend on your personal circumstances and the objectives of the company.
Profit extraction – a waiting game
The first question to consider is whether you personally need or want the cash, or whether it might be best to leave profits in the company. One of the main benefits of a company when compared to a sole trader business is that there is flexibility in when and how you extract profits, giving you the control to ensure you are optimising your overall tax position.
For example, if you are starting up a new business and continue to receive PAYE income from another employer, it may be beneficial to leave profits for reinvestment in the business and avoid unnecessary personal tax liabilities if you receive sufficient funds from employment. Or, if the company is your main or only source of income, it will depend on the level of profits you have available for extraction, and how much of your tax bands you have left to utilise in a given year. Sometimes it is worth waiting until the next 5th April to declare further salary or dividends if, for example, you’re on the cusp of becoming a higher or additional rate taxpayer, or if you’re about to start losing your personal allowance.
Despite rising rates of dividend tax and the lowering of the dividend allowance, it may still be optimal to declare a modest salary with a top up declared in dividends, but this will depend on individual circumstances. Dividends and salary are not the only methods of extracting cash from your company and tax benefits can arise by extracting profits through other means.
- Dividends are not deductible for corporation tax purposes, but they do not attract NICs charges.
- PAYE salary will incur NICs over a certain level, but the gross salary + employer’s NICs will be deductible for corporation tax.
- Charging interest on shareholder loans, or charging rent on privately held assets can in certain circumstances be an effective way to extract funds without incurring NICs.
- A contribution by the company into a personal pension pot can be an exempt benefit with limited short term tax implications, while being tax deductible for corporation tax.
- Involving spouses or adult children in the company can also yield significant tax savings by utilising all personal allowances and lower income bands where available.
- If you have a short-term need for cash and the company is cash rich, consider taking a loan from the company; the company will face a corporate tax charge on the loan which is reclaimable once the loan is cleared in future. If the loan is £10k or under there may be no personal tax implications.
- Marginal rate relief is available for corporation tax from 1 April 2023, therefore if the company is marginally above the lower profits threshold (currently £50k assuming no associated companies) consider if company profits can be reduced by declaring salary or paying into a pension such that a lower rate of corporation tax can be achieved.
A high-level summary of the tax consequences of the various types of remuneration are summarised in the table below:
|Type of income||Income tax||National Insurance Contributions||Corporation tax|
|Salary||Yes – at 20%, 40%, 45%||Yes – employer’s at 13.8%, employee’s at 12%, 2%||CT deduction on gross salary and employer’s NICs|
|Dividends||Yes – at 8.75%, 33.75%, 39.35%||No||No CT deduction available|
|Interest income||Yes – at 20%, 40%, 45%||No||Deductible for CT purposes if paid within 12 months of the period end|
|Rental profits||Yes – at 20%, 40%, 45%||No||Deductible for CT purposes if wholly and necessarily for the purposes of business|
|Loan from the company||Yes – marginal rate of tax if loan > £10,000||No||A s455 CT holding tax is payable on director/shareholder loans|
|Pension contributions||No – as long as annual allowance is not exceeded||No||Deductible for CT purposes in the period when paid (subject to spreading provisions on excess contributions)|
Other key factors:
There will be a number of other factors that may influence your profit extraction strategy, and it is important to maintain a balance between what is tax efficient, what works commercially for the company, and what is aligned with your personal goals.
Some commercial factors to consider are:
- External investment may limit the options available to you or provide legal restraints. The contents of your articles of association and rights associated with your share classes may also limit your flexibility;
- Excess funds held within the company may restrict eligibility for future reliefs such as business property relief for inheritance tax, or business asset disposal relief on future sale of the company;
- Dividends can only be paid out of distributable reserves, whereas other forms of remuneration may provide greater flexibility;
- As a director of the company you have a fiduciary duty to act in the best interests of the company first and foremost;
- Income streams which are not contractually guaranteed can impact bank loans and mortgages available to you;
- Certain forms of remuneration negatively influence company profits which may affect corporate credit ratings or banking covenants;
- Leaving profits in the company may help facilitate greater future growth, potentially creating more value in the long term, and providing flexibility for funding sources for future projects.
How to decide?
How to bring business profits into personal hands in a tax efficient manner and aligning your remuneration strategy with the company’s commercial objectives continues to be a recurrent and critical issue for owner managers. Ensuring all opportunities are exploited, and commercial influences managed, can yield significant tax and commercial benefits.
It is important to remember that the best profit extraction route will be extremely dependent on your individual circumstances and may differ year on year. At Menzies we use our experience and expertise when working with private business owners and entrepreneurs to find a strategy that works effectively for you and your business.