Business owners will be looking closely at tax-efficient ways of extracting cash in the light of the new 50% tax rate from next year.
Let's take a look at the four main ways of extracting cash from owner-managed companies –
although there are others such as company payments for use of assets and other benefits in kind.
In all cases it is important to make careful calculations as the position will vary depending on shareholding arrangements and the company's marginal tax rates.
Salaries/bonuses
The net amount received by an individual from extracting £100 of profit by way of salary or bonus taxed at 40% is £52 and, post-April 2010, at 50% this will be £43.
Dividends
Similarly (assuming a corporation tax rate of 28%), the net amount received by a top rate taxpayer extracting £100 of profit by way of dividend, currently taxed at 32.5%, is £54.
Post-April 2010 this dividend will be taxed at 42.5%, and the amount received by the individual will be £46.
In both cases this is marginally better than a bonus.
For smaller companies paying tax at 21%, the net cash from a dividend per £100 of profit rises to £59 and will be £50 post- 5 April 2010. So dividends become much more attractive than salaries and bonuses, and pre-5 April 2010 dividends look particularly beneficial.
Pension contributions
Pensions continue to be a tax-efficient form of cash extraction.
However, the Chancellor announced in the 2009 Budget that with effect from 6 April 2011, tax relief will be restricted for individuals whose taxable income exceeds £150,000 and he immediately introduced antiforestalling rules that could impose a tax charge on pension contributions paid by such individuals in the current tax year 2009/10 and in 2010/11.
Consequently this whole area has once again become very complicated and expert advice should be sought on how the tax changes impact on existing and proposed arrangements.
Pension contributions will continue to be tax deductible for the company and the pension funds themselves will accumulate tax-free until they are paid out, either in the form of a tax-free lump sum (capped at 25%) or as a pension subject to income tax rules.
EFRBS
An Employer-Financed Retirement Benefits Scheme (EFRBS) is essentially an unregistered pension scheme. Although its purpose is to provide retirement benefits to employees, it will also help in respect of the new 50% tax rate and new pension capping rules. Short-term access to cash by way of loans is also a possibility.
EFRBS can be particularly attractive to non-UK domiciled individuals and those seeking to mitigate the impact of the £30,000 remittance basis charge. A corporation tax deduction is deferred until pension or earnings are drawn down.
Let's take a look at the four main ways of extracting cash from owner-managed companies –
- salaries/bonuses;
- dividends;
- pension contributions; and
- EFRBS
although there are others such as company payments for use of assets and other benefits in kind.
In all cases it is important to make careful calculations as the position will vary depending on shareholding arrangements and the company's marginal tax rates.
Salaries/bonuses
The net amount received by an individual from extracting £100 of profit by way of salary or bonus taxed at 40% is £52 and, post-April 2010, at 50% this will be £43.
The key planning point is that it is clearly beneficial to pay bonuses before 5 April 2010.
Dividends
Similarly (assuming a corporation tax rate of 28%), the net amount received by a top rate taxpayer extracting £100 of profit by way of dividend, currently taxed at 32.5%, is £54.
Post-April 2010 this dividend will be taxed at 42.5%, and the amount received by the individual will be £46.
In both cases this is marginally better than a bonus.
Again, it is clearly beneficial to pay dividends before 5 April 2010.
Pension contributions
Pensions continue to be a tax-efficient form of cash extraction.
However, the Chancellor announced in the 2009 Budget that with effect from 6 April 2011, tax relief will be restricted for individuals whose taxable income exceeds £150,000 and he immediately introduced antiforestalling rules that could impose a tax charge on pension contributions paid by such individuals in the current tax year 2009/10 and in 2010/11.
Consequently this whole area has once again become very complicated and expert advice should be sought on how the tax changes impact on existing and proposed arrangements.
Pension contributions will continue to be tax deductible for the company and the pension funds themselves will accumulate tax-free until they are paid out, either in the form of a tax-free lump sum (capped at 25%) or as a pension subject to income tax rules.
EFRBS
An Employer-Financed Retirement Benefits Scheme (EFRBS) is essentially an unregistered pension scheme. Although its purpose is to provide retirement benefits to employees, it will also help in respect of the new 50% tax rate and new pension capping rules. Short-term access to cash by way of loans is also a possibility.
EFRBS can be particularly attractive to non-UK domiciled individuals and those seeking to mitigate the impact of the £30,000 remittance basis charge. A corporation tax deduction is deferred until pension or earnings are drawn down.
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