The Most Efficient ways to Draw Profits from your Company

As a business owner, you have the authority and freedom to draw as much money out of your company as you choose. However, it’s not as simple as giving yourself a big paycheck, as taxes will significantly drain your income if you withdraw directly.

In this article we’re going to list the most tax-efficient methods of extracting profits from your business while staying within the boundaries set by the law.

Minimum Salary

Instead of giving yourself as high a salary as possible and getting placed in a high tax band, go for the minimum amount that reduces the amount of tax you have to pay while still qualifying for the State Pension. At least 10 years of NICs are required to start receiving State Pension and 35 years to get all of it.

The minimum weekly income for employers to start paying NICs for the 2020/21 tax year is £169, so you can have an annual salary of £8,788 and still qualify for State Pension. Since this is below the £12,500 Personal Allowance limit, you won’t have to pay any Income Tax on this salary.

If you have employees, you can also take advantage of Employment Allowance to reduce your annual NICs by as much as £4,000. You’d be able to pay yourself a salary equal to the Personal Allowance limit, use the NIC reduction from the Employment Allowance to cover all of your Employer NIC, and only have to pay for your Employee’s NICs.

Dividends

Dividends are not subject to National Insurance Contributions (NICs) no matter what your personal Income Tax rate or your company’s Corporation Tax rate is. You can receive up to £2,000 in dividends without having to pay tax.

Once you go above £2,000, the dividends you receive are taxed at a rate determined by your Income Tax band, with thresholds that differ from Income Tax rates.

Income Tax band Taxable income Income Tax rate Taxable income on dividends Dividend tax rate
Basic rate £12,501 - £50,000 20% £2,001 - £37,500 7.5%
Higher rate £50,001 - £150,00 40% £37,501 - £150,000 32.5%
Additional rate Over £150,000 45% Over £150,00 38.1%

Do note that you can only pay dividends if your company profits are enough to cover them and those profits will be taxed at the current Corporation Tax rate of 19%. It’s also important to remember that dividends are added to your total income, so there’s a chance that you can be placed into a higher tax band and thus have to pay more tax on dividends above £2,000.

However, the fact that the rates for corporation and dividend tax are lower than the rate from overall Income Tax makes it much more tax-efficient to draw profits through dividends than through a high salary. This is why the best practice is to give yourself a minimum salary to qualify for State Pension as mentioned in the previous section, while earning the majority of your income with dividends.

Pensions

Making pension contributions provides both short and long-term financial benefits.

Contributing to a pension as an individual gives you Income Tax relief, while doing the same through your company gives you Corporation Tax relief, as long as you make them before the end of the tax year. Because a pension isn’t a benefit, you also don’t have to worry about tax or National Insurance liabilities.

You can contribute up to 100% of your earnings with a maximum of £40,000 a year, although this number is reduced for those earning over £150,000 annually.

By the time you gain access to the pension fund at 55, you can withdraw 25% of the entire pot tax-free. Beyond that, you will be taxed at the rate when you withdraw, which should be lower than when you first started making contributions.

Rent

There are two ways you can rent property to your company and make tax-efficient profits.

You can do so as an individual owning the property. The company’s payments are exempt from NICs all the while being tax-deductible for the company.

The other way is to do so via a pension scheme. Payments are tax-deductible for the company, and since it’s done through a pension, they also won’t be taxed.

Private Investments

You can take the money you earn from your business and invest it in other private companies. There are two major investment avenues to take to maximise profits.

1. Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS)

For EIS, you can invest as much as £1,000,000 or as low as £2,000 into a newly incorporated company with 30% Income Tax relief. Holding onto the investment for over three years results in no Capital Gains Tax and Inheritance Tax on your gains. If you don’t get returns, you can still get loss relief.

For SEIS, you can invest as much as £100,000 a year with 50% Income Tax relief and another 50% Income Tax relief if you reinvest your gains. There are no Capital Gains Tax and Inheritance Tax on returns if you hold onto the investment for over three years, as well as loss relief from getting no returns.

2. Venture Capital Trusts

A manager invests as much as £200,000 a year across multiple new businesses with 30% Income Tax relief, as well as tax-free dividends and capital gains. You will have to pay your manager, and there is no loss relief.

Employing Family Members

A family member that has little or no income can be employed in your company and given a minimum salary that’s deductible to your Corporation Tax by 19%. You have to justify the amount you pay them to qualify for the tax savings. Hiring them as a director or as a company secretary can be reason enough for the salary.

Retiring Abroad

If you are already making plans for retirement, you can leave your profits from your company for now and withdraw them later on tax-free if you decide to retire abroad. You do have to be out of the country for more than five years.

Do be mindful of the tax agreements the UK has with the country you are planning on retiring in. You might still get taxed for the income you receive from the UK in your new home depending on which country you settle in.

Most countries that UK citizens eventually go to retire have double-taxation agreements, such as France, Australia, and the US. You do have the benefit of getting double tax relief in those cases. The government has a full list of countries and their tax treaties with the UK for more details.

Selling Company Shares When Exiting

When you see an opportunity to sell the business while it is growing and profitable, you can gain much more by leaving money in the company then withdrawing it as capital gains. This is more cost-efficient than taking the money as salary or dividends, as the rate for Capital Gains Tax is 20% standard and 10% if you qualify for Entrepreneurs’ Relief.

You need a formal liquidator if the reserves in your business when you sell it are more than £25,000. The business also cannot have more than 20% of its income or assets considered as non-trading.

Lastly, selling the company via shares will make it easier to extract the profits instead of selling the business and its assets. Doing the latter opens you up to the possibility of being taxed twice.

Getting Advice from an Accountant

Navigating the tax rules when drawing profits from your business in the most efficient manner is certainly doable without breaking any of those rules. However, if you feel overwhelmed and want to ensure you don’t get caught out by the legalese and legislation, give us a call at Plummer Parsons and we can talk to you about your business and the options available that will allow you to maximise your income and minimise your tax bill.