“What’s the most tax-efficient way to take funds out of my company?” is perhaps the most common question put to accountants by their owner-managed company clients. The answer used to be simple: “Take a salary up to the level of the personal allowance and take the rest as a dividend”. Unfortunately, we are no longer able to give such a straightforward, one-size-fits-all answer. Put simply, the most honest answer we can give without performing individualised calculations is “It depends”!
If the director(s) need to take a market rate salary for commercial reasons (including obtaining finance in their own name or for making personal pension contributions), this should be a priority.
Individual calculations need to be carried out to arrive at the optimal profit extraction strategy for all but the most straightforward businesses. This is because the optimal extraction method will depend on a range of factors, including:
- The company’s profit level, which determines its rate of corporation tax;
- The number of director/shareholders;
- The available distributable reserves in the company;
- The director/shareholder’s other income, which determines their marginal rate of income tax and the amount of Personal Allowance available to them.
- The director/shareholder’s age - those aged 66 or over do not pay employees National Insurance Contributions;
- The availability of the £10,500 Employment Allowance (EA) - the company might not qualify for EA or it might already be utilised by other employees’ salaries.
Consideration then needs to be given to the cash requirements of the director/shareholders. Extracting all available funds from the company is likely to incur a higher tax cost than extracting a set figure that is sufficient to cover living costs. Funds retained in the company will not be subject to income tax until they are taken out of the company by the director/shareholders. Alternatively, funds may be retained in the company with a view to realising a capital gain on the eventual sale or liquidation/striking off of the company. The capital gain will be subject to Capital Gains Tax and could be eligible for Business Asset Disposal Relief.
For many director/shareholders, the ‘classic’ extraction model of taking a salary equal to the £12,570 personal allowance, followed by dividends sufficient to cover their living requirements, is likely to be a tax efficient strategy, however, as can be seen above, there are many factors that may change the position. If you wish to discuss your profit extraction plan with us please get in touch – we’d be happy to help!