When I was a practicing Chartered Accountant, the most asked question was probably “How do I save Tax?”
No one likes to pay tax, but it is a necessary evil of any modern society and if we want to have the luxuary of safe roads, an NHS service, a police force and our bins collected each week, as just a few examples, then tax is needed to pay for all that.
However, there is nothing wrong in trying to save tax where you can and to try and avoid tax, but not to evade tax! To put the record straight avoidance is legal whereas evasion will get you into trouble!
Dealing with a limited company within the UK, as these are the rules that I know, then there are probably four ways to get money from your business – each of which can be more or less tax efficient.
1. Salary – quite simple, you can vote yourself a salary on a monthly basis and the company will pay the tax and National Insurance (NI) on this for you. The company will deduct both tax and NI from your gross salary and pay you the net amount and the company will also have to pay over company NI too. Therefore, this method of payment is not so tax efficent, however the salary is tax deductible, as far as the company is concerned.
2. Benefits in kind – Another way to receive remuneration from your company is to provide yourself with certain perks. For example, a company car, a mobile phone, a holiday villa and private medical insurance to name a few. You will be taxed on the benefit in kind and the UK Government has a method of calculating just how much you should be taxed. For example, company cars are taxed dependent upon the value when new and on how fuel efficient they are. So the more the cost when new and the less fuel efficient they are the more you will be taxed! in a nut shell! The way I see things is that if you buy a relatively fuel efficient car, that is not too expensive (say less than £20,000) and you do not do too many business miles, then a company car is the way to go. However, there are so many permutations for this and you will need to look at your own personal circumstances and the car you are looking to buy.
3. Dividend – I would argue that dividends are quite tax efficient, as neither the company nor the individual pays NI on a dividend. However, dividends are not tax deductible for the company, so the company will pay Corporation Tax on these profits distributed as a dividend. The effective rate of tax on a dividend for 40% tax payers is only 25% though, which has to be good. And for those who remain below the 40% threshold, there is no tax to be paid on a dividend.
4. Capital distribution – Probably the most tax efficient way to be paid is by building up the value of your company, without drawing out too much by way of payment using the above 3 methods. Then put you business onto the open market and sell it to the highest bidder! In these circumstances you will pay Capital Gains Tax (CGT) on the gain you make on the sale – the present legislation in the UK is as follows:
“The relief
The relief will take effect from 6 April 2008 alongside the CGT reform programme announced at the Pre-Budget Report.
The relief will be available in respect of:
gains made on the disposal of all or part of a business, or
gains made on disposals of assets following the cessation of a business
by certain individuals who were involved in running the business.
The first £1 million of gains that qualify for relief will be charged to CGT at an effective rate of 10 per cent. Gains in excess of £1 million will be charged at the normal 18 per cent rate.
An individual will be able to make claims for relief on more than one occasion, up to a lifetime total of £1 million of gains qualifying for relief.”
So if you have a gain of less than £1million then you will only pay £100,000! whereas if you had drawn a dividend of £1million the tax would have been £250,000! And to receive a net salary of £900,000 (i.e. the total gain of £1m less the CGT of £100,000) the tax and national insurance paid on this would be a whole lot more, bearing in mind the 40% threshold is presently just of £40,000! So the majority of the £900,000 would be taxed at 40%, which is ignoring the employees NI, not to mention the Employers NI!
Further more, if you are prepared to emigrate before you make the sale you could potentially pay zero tax! Be careful where you emigrate to, as you don’t want to jump out of the fying pan and into the fire! For example, in the Isle of Man they do not have CGT so you would pay no tax on the business sale!
Before you do anything describe above I would recommend that you speak with your accountant or tax adviser!
Cheers, great stuff, I like.
Thank you for this article. Yes of course, taxes can always be planned but it is important to know how it works.
Excellent article, thank you.
For more recent readers (since it was written over 2 years ago, at the time of writing this!) note that:
“The limit increased to £2 million from 6 April 2010 and the Budget proposes a further increase to £5 million from 23 June 2010.”
-Direct quote from HMRC website.
Hi. re Simon’s query above, and your reply “If the whole of the £18,000 is a loan then this amount can be withdrawn tax free without having to pay PAYE (Income tax or National Insurance)”.
I am in the same situation, invested money in the business to start with and have been repaying that back to myself since. In that time I have paid no NI or PAYE.
Two questions: 1. As I have not paid NI in the time, do I have a black home in my contributions, or is it covered given the loan repaying scenario I am in, and 2. How should I start remunerating myself now, given the loan is almost repaid? Should I draw a basic salary and thereby have my NI etc paid via the company? I don’t want to leave myself in a situation where I do not qualify for state benefits having been in the system for 10 yrs before setting up my business! Thank you.
My client is a limited company onwed outright by a hisband & wife team.
For some years they have employed another family member who has been a significant contributor to the sales growth of the business in that time.
If the business is to be sold in, say, 3 years time, what would be the most tax efficient way of the other family member being duly rewarded for their effort and contribution in growing the value of the business (at present they do not own any shares of any kind in the business)?
I am not sure how you are trading, but on the assumtion you are using a limited company, then this is correct so long as the £18,000 has been paid in to the business on the basis of a loan. If the whole of the £18,000 is a loan then this amount can be withdrawn tax free without having to pay PAYE (Income tax or National Insurance). However, if the business makes a profit in the same period over which the loan is repaid, the company will pay Corporation Tax on the profits made in that period at the rate applicable to the level of profits made. I hope this makes sense and answers your question – if you have any further questions by all means ask and I will help where I can.
Is my accountant right- I have invested £18000 of my own savings into my business and the bank account and until I have drawn down this complete amount I do not need to pay any tax or national insurance until I have taken back my initial investment? Please help anyone as I don’t want to be stung with a massive tax bill if this is wrong.
I’m surprised that no insurance guys have ringed in on this subject. It may be because the laws are different in Canada than the UK but I don’t beleive that is the case. I am talking about if your corporation has retained earnings that are staying in the corporate account for tax reasons. A business owner (or owners) could use some of that cash purachase a Life insurance policy on themselves, and have the business as the owner beneficiary. Upon death of the life insured, the funds go into an account of which a large amount can be paid out tax free the subsequent business owners (likely the insured’s family).
I’m so glad I left the UK for the Isle of Man. The tax laws are so simple to follow.
No corporation tax.
Pay 10% of everything you make over 9K and 18% if you are a top earner.
Of course, you spend a fortune getting on and off the rock but its worth it 🙂
Taxes can always be planned but need some basic knowledge of how the taxation works. I think salary and perks are the most common of them all. Almost all company owners do that.
.-= almir´s last blog ..Medical billing training =-.
Yes you can take the profits as dividend, but make sure the amount you take is from “distributable profits” and that the profits are declared in the right way according to the Articles of Association for the company.
Also, make sure that the company is not subject to the IR35 rules, in which case HMRC will deem a salary paid and employers NI on this where no salary has been drawn.
The other consideration for your friend is in terms of pensions both personal and state, as it is worth paying at least a minimal salary so that some National Insurance is paid so that his state pension is contributed to and where he has a salary he will then be able to contribute to a personal pension – for this he will need to seek the advice of an Independent financial adviser (IFA). Hope this helps.
Dear writer,
I have been asked by my friend who has their own limited company (they are the only employee), as a qualified accountant, what i believe the most tax efficient method to receive earnings from their company would be.
I searched through the web and found your article to be quite informative, yet it seems too good to be true that as an employee of the company he can take a ‘dividend’ for any amount and have only the company pay coporation tax on profits (with this amount added back as a disallowable deduction). Surely there must be limits placed (by HMRC)for such divident payment scenarios??
Thanks in anticipation.