Tax efficient profit extraction from a limited company

Sole traders and partnerships will no doubt have been advised at some point by their accountant on the relative merits of incorporation that is changing the legal structure of their business into a limited company.

Incorporation allows greater flexibility in how cash generated from the business can be extracted. Some of the business profits may be paid as dividends which can have National Insurance Contribution (NIC) savings for employer and employee alike.

Incorporation also allows for company profits to be paid as employer pension contributions which also do not attract NIC for the employer and employee and are normally a deductible expense for corporation tax purposes.

It is also possible for profits to be retained in the business and not distributed. If cash is retained indefinitely then it would eventually form part of the value of the business on sale and is likely to be subject to capital gains tax (CGT) in the hands of the director after allowing for any entrepreneur’s relief that may be available.

Excess cash holdings can put entrepreneur’s relief and business property relief at risk in some circumstances.

The options for a director looking to extract profits from a company will include the following: -

Salary or bonus payments – directors are employees by virtue of their directorship and will usually have a contract of employment or service agreement and receive at least the minimum wage.

Salary or bonus is paid subject to employer’s NIC at 12.8% as well as income tax at 40% for a higher rate tax payer and employee’s NIC at 1% (for earnings over the Upper Earnings Limit).

Dividends -- are paid subject to corporation tax at the company’s rate of 21%, 28% or 29.75% depending on the taxable profits.

Employer pension contribution -- where paid to a registered pension scheme employer contributions are normally an allowable deduction for corporation tax purposes provided there is no non trade purpose for the contribution. Contributions to a registered pension scheme should not attract employer NIC, employee NIC or a tax charge on the employee.

A combination of salary, dividends employer and employee pension contribution can create a very tax effective remuneration strategy for a shareholding director of a limited company.

Note that from 6th April 2010 additional rates of tax will apply to those with taxable incomes in excess of £150,000. The rates will be 42.5% for dividend income and 50% for gross taxable income from other sources.

Expert Financial Solutions Ltd Chartered Financial Planners and independent financial advisers advise many directors, sole traders and partners on their pension and retirement savings. Our highly qualified and professional financial planners are pension experts and have the highest level of pension qualifications including G60 advanced financial planning certificate pensions, and AF3 advanced diploma in financial planning pensions.

September 2009.

Expert Financial Solutions Ltd chartered financial planners and independent financial advisers IFA financial planners based in Witney, Oxford, Oxfordshire. We provide independent financial advice, pension advice, investment advice, retirement advice, annuity advice, SIPP advice pension drawdown advice, pension transfer advice, wealth management and pensions on divorce advice in Oxford, Oxfordshire, Gloucestershire, Buckinghamshire, Wiltshire and Berkshire, Abingdon, Banbury, Bampton, Bicester, Burford, Chipping Norton, Cheltenham, Cirencester, the Cotswolds, Henley on Thames, Kidlington, Lechlade, Oxford, Wantage, Witney and Woodstock. Pension specialists, retirement planning specialists, pension transfer specialists, pension annuities, specialist pension advisers, investment advisers, and inheritance tax IHT mitigation and trust investment. Chartered Financial Planner. Oxfordshire's only Resolution qualified and Resolution accredited IFA for pensions on divorce and financial neutral for collaborative divorce.