For owners of limited companies, the extraction of profits is not just about maximising immediate gains but ensuring long-term financial health and tax efficiency.
As tax laws and regulations evolve, staying informed and adaptable is key. This guide provides insights into optimising your approach to profit extraction, focusing on tax-efficient strategies that align with your business objectives and personal financial goals.
Understand your options
Limited-company owners can extract profits in several ways, each with its own tax implications. The most common methods include:
- salaries
- dividends
- pensions
- loans.
A balanced combination of these methods, tailored to your personal and business circumstances, can minimise your tax liability and maximise your income.
Salaries and National Insurance Contributions (NICs)
Paying yourself a salary is straightforward but comes with NICs for both the employer and the employee. However, by setting your salary at an optimal level, you can minimise NICs while still benefiting from state pension and benefits entitlement. The key is to pay yourself a salary just below the NIC threshold, ensuring you remain eligible for state benefits without incurring unnecessary tax.
Dividends
Dividends are paid from after-tax profits and are subject to different tax rates than salaries. They do not attract NICs, making them a popular choice for profit extraction. However, dividends can only be paid out of profits, so it’s essential to ensure your company’s financial health is not compromised. The tax rates on dividends are lower than income tax on salaries, but careful planning is required to balance dividends with other forms of income to remain within lower tax bands.
Pensions
Pension contributions stand out as a particularly tax-efficient method of profit extraction. Contributions made by the company can reduce its corporation tax bill, as they are considered a business expense. Moreover, pension contributions do not count towards your personal income, meaning they’re exempt from income tax and NICs up to the annual allowance. This strategy not only aids in tax planning but also bolsters your retirement savings.
Director’s loans
Directors can borrow from their company through directors’ loans. While this method can offer short-term financial flexibility, it’s fraught with tax implications if not managed carefully. Loans must be repaid within nine months of the company’s year-end to avoid additional taxes. Interest on the loan must also be at a market rate to prevent being taxed as a benefit in kind.
Mix and match
No single method of profit extraction is superior in all circumstances. A mixed approach allows for flexibility and optimisation of tax efficiency. The decision should be influenced by factors such as your personal tax bracket, the company’s financial performance and long-term objectives.
Use allowances and reliefs
Taking full advantage of tax allowances and reliefs is crucial. This includes ensuring you use your personal allowance, dividend allowance and capital gains tax allowance where applicable. For those involved in innovation, schemes like research and development (R&D) tax credits can offer significant savings, further reducing your corporation tax bill.
Planning and compliance
Effective tax planning requires a forward-looking approach and an understanding of current legislation. Regular reviews of your profit extraction strategy, in light of legislative changes and business performance, are essential. Compliance with tax laws and timely filings will avoid penalties and interest, which can erode the benefits of tax-efficient planning.
Get help
Optimising tax-efficient profit extraction requires a bespoke strategy that considers the unique aspects of your business and personal financial situation. By blending salaries, dividends, pensions and potentially directors’ loans, while maximising the use of available allowances and reliefs, you can achieve a balance between immediate financial benefits and long-term fiscal health.
The landscape of tax efficiency is complex and ever-changing. At PBA we understand the nuances of tax legislation and its application to your specific circumstances. With our invaluable guidance, we can manage your profit extraction, ensuring your strategy remains robust, compliant and aligned with your goals.
Contact us for help with maximising your profit extraction.