Here we outline some of the key areas to consider.
Corporation tax is the tax 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 requires careful consideration, particularly as sweeping changes to the dividend taxation rules are planned for 2016.
A dividend is paid free of NICs, whilst a salary or bonus can carry up to 25.8% in combined employer and employee contributions. However, a salary or bonus is generally tax deductible for the company, whereas dividends are not. 5 April 2016 is the last date for paying a 2015/16 dividend, and any higher or additional rate tax on that dividend will not be due until 31 January 2017.
Note that the Government has announced its intention to abolish dividend tax credit from 6 April 2016 and introduce a new Dividend Tax Allowance of £5,000 a year. The new rates of tax on dividend income above the allowance will be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. These rates replace the current effective tax rates of 0%, 25% and 30.6%. While there will still be benefits for a director-shareholder taking a dividend over a salary, the amount of tax saved will be reduced. It may therefore be worth increasing your dividends before 6 April 2016, although there may be other tax issues to consider, such as loss of the personal tax allowance if your total ‘adjusted net income’ exceeds £100,000.
More ways to extract profit
You may also want to consider alternative means of extracting profit, which might include the following:
For those expecting to liquidate their company in the next few years, profits might be left in the company to be eventually drawn as capital.
Current rules allow retained profits distributed on liquidation to be subject to capital gains tax, with a potential tax rate as low as 10% if Entrepreneurs’ Relief is available. However, caution is advised as high cash reserves held without a clear business purpose or substantial investments can potentially jeopardise Entrepreneurs’ Relief or IHT Business Property Relief.
As the above points suggest, incorporation may give some scope for saving or deferring tax than operating as a self‑employed person or partner.
Of course, incorporation may not suit all circumstances, and the ‘IR35’ rules specifically counter the use of ‘personal service companies’ to reduce tax, but we will be pleased to discuss how incorporation might apply to you and your business.
Tax‑free allowances, such as mileage payments, apply when you drive your own car or van on business journeys. The statutory rates are 45p per mile for the first 10,000 miles and 25p per mile above this. If you use your motorbike the rate is 24p per mile, and you can even claim 20p per mile for using your bicycle!
Employer pension contributions can be a tax‑efficient means of extracting profit from a company, as long as the overall remuneration package remains commercially justifiable. The costs are usually deductible to the employer and free of tax and NICs for the employee.
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 rent, which can be anything up to the market value, if you wish.
The rent is usually deductible for 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 or when you decide to sell the property, so care needs to be taken to weigh up the pros and cons.