Our simplified guide to tax efficient extraction of money from your company, part of a new series on Tax Made Simple
One of the most important aspects of our work at Schoolgate is helping our clients get the most out of their business as possible, financially speaking, when it comes to paying tax. It is almost inevitable that the idea of ‘tax avoidance’ stirs up uncomfortable emotions for most business owners, particularly with high profile imbroglios such as the Paradise Papers making regular appearances in the media. However, at Schoolgate, we believe that not only is it important to be fully aware of the limitations of your tax obligations, but it is even irresponsible as a business owner to pay more than you have to by law if you approach these obligations in an ethical and common-sense manner, as we encourage all our clients to do.
As a result, we have decided to begin a new series, Tax Made Simple, for business owners to provide a concise and understandable guide to what you should pay and how to save money on your tax bill without registering a legal entity in Bermuda.
Our first instalment will cover a general overview of profit extraction strategies, i.e. how to take money out of your company in the most tax-efficient way.
Salary & Dividends
The most common ways of taking money out of a company are via salary payments and dividends. Most people are familiar with the way salaries are taxed, with a personal allowance which is tax free (£11,850) and various thresholds which are taxed at different rates (20% beyond personal allowance; 40% on earnings above £46,350*).
Dividends are sums taken out of the reserve profits of the company. Until April, you could earn £5,000 in dividends tax-free. Unfortunately for business owners, this has dropped to £2,000 for 2018-19.
A fairly common tax planning strategy is to take a low basic salary, below the personal allowance amount, so that it does not attract income tax, but high enough so that you are paying National Insurance and are therefore entitled to the benefits this entails. You then make up the balance with income from dividends, which are not subject to National Insurance. However, unlike salaries, dividends are not tax-deductable. This means that the more money you take from the company as a salary, the less corporation tax you have to pay on the profits, but this is not true of a dividend. On the flip side, since you have already paid corporation tax on the company profits, the taxes on dividends are lower than those on salaries (only 7.5% if your overall income is below the £46,350 threshold, and 32.5% if above). As a result, there is a balance between how much to take as salary and how much as a dividend (bearing in mind taxes and National Insurance payable overall).
* Please note rates differ in Scotland
Source: Schoolgate Accounting Services | 30-4-18