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Category: Tax Planning

Extracting funds from a family company without retained profits

Extracting funds from a family company without retained profits

Many family companies have struggled as a result of the COVID-19 pandemic and may no longer have any retained profits. Where this is the case, they may need to rethink how they extract funds from their company to meet their personal bills.

Dividend problem

A popular and tax-efficient strategy is to pay family members a salary equal to the primary threshold, set at £9,500 for 2020/21, or, if the employment allowance is available, a salary equal to the personal allowance of £12,500, and to extract further profits as dividends.

Requirement to pay dividends from retained profits

Under company law, dividends can only be paid from retained profits. This means that if a company lacks sufficient retained profits to pay a proposed dividend, they will not be able to pay that dividend legally. The ability to pay a dividend is constrained by the available retained profits.

Dividends must also be paid in proportion to shareholdings; however, the use of an alphabet share structure can provide flexibility.

Other options

Despite not having any retained profits, your company may have money in the bank. This may provide options for taking funds from the company where dividends are not an option.

Unlike dividends, salaries and bonus payments can be made where the company lacks profits, even if this results in a loss. Funds can also be extracted in the form of benefits in kind or, if the business is run from home, rent.

This will not always be ideal, from a tax perspective, but may be necessary. However, the directors must be wary of inadvertently trading while insolvent.

The company could also consider making a loan to the director. This can be a useful short-term option and it is possible for a director to borrow up to £10,000 for up to 21 months tax-free. However, there will be tax implications if the loan remains outstanding nine months and one day after the end of the accounting period in which it was made.

Talk to us

We can discuss ways to navigate the COVID-19 pandemic and extract funds from an unprofitable family company.

September 30, 2020

Optimal salary for 2020/21

Optimal salary for 2020/21

A popular profit extraction strategy for personal and family companies is to pay a small salary and to extract further profits as dividends. With new National Insurance thresholds applying for 2020/21, what is the optimal salary for the new tax year?

Starting point – what can be paid free of tax and National Insurance?

Assuming the director has the full personal allowance for 2020/21 of £12,500 available, the optimal salary will be dictated by National Insurance considerations. Unless the director already has the 35 qualifying years needed to secure a full single tier state pension, it is worthwhile paying a salary at least equal to the lower earnings limit, set at £6,240 for 2020/21, to ensure that the year counts for state pension and contributory benefits purposes.

For 2020/21, the point at which employer contributions start (the secondary threshold) is lower than the point at which employee contributions start (the primary threshold). The secondary threshold is set at £8,788 for 2020/21 (£169 per week; £732 per month), whereas the primary threshold is set at £9,500 (£183 per month; £792 per month).

Assuming that the director is over the age of 21 and the employment allowance is not available (as is the case where the sole employee is also a director), the maximum salary that can be paid free of tax and National Insurance is £8,788 – equal to the secondary threshold.

Employer contributions for under 21s do not start until the upper secondary threshold for under 21s is reached (set at £50,000 for 2020/21). Thus, where the director is under 21, a salary equal to the primary threshold of £9,500 per year can be paid free of tax and National Insurance. This is also the case if the employment allowance is available (for example, in a family company scenario).

Is it beneficial to pay a higher salary?

Salary costs and any associated National Insurance are deductible in computing the company’s profits for corporation tax purposes. Thus, if the corporation tax deduction (at 19%) is more than any National Insurance or tax paid on the additional salary, paying a higher salary can be worthwhile.

If the director is 21 or over and the employment allowance is not available, it is worthwhile paying a salary up to the primary threshold of £9,500. On earnings between £8,788 and £9,500, employer National Insurance contributions of 13.8% are due, but this is outweighed by the corporation tax deduction on the additional salary and the associated employer’s National Insurance. However, once the primary threshold is reached, both employer and employee contributions are due (at 13.8% and 12% respectively) on further earnings. As these outweigh the corporation tax deduction, it is not worth paying a salary above £9,500 a year. So, where the director is aged 21 or over and the employment allowance is not available, the optimal salary for 2020/21 is £9,500 a year (£792 per month).

If the director is under 21 or the employment allowance is available, as seen above, a salary of £9,500 (equal to the primary threshold) can be paid free of tax and National Insurance. Above this level, primary National Insurance contributions are payable at 12% until the personal allowance of £12,500 is reached. As the associated corporation tax deduction is higher than the National Insurance cost, it is worth paying a salary of £12,500. Above this, however, income tax at 20% is also payable, outweighing the corporation tax deduction. Consequently, in these circumstances, the optimal salary is equal to the personal allowance of £12,500 a year.

Determine your optimal salary

As shown above, the optimal salary depends on personal circumstances. Speak to us for help in crunching the number and determining the optimal salary for your situation.

April 8, 2020

Entrepreneurs’ relief – reduction in lifetime limit

Entrepreneurs’ relief – reduction in lifetime limit

Prior to the Budget, there had been much speculation that that entrepreneurs’ relief would be abolished. In the event it stayed – albeit with the new name of ‘Business Asset Disposal Relief’ – and a much-reduced lifetime limit.

New £1 million lifetime limit

The lifetime limit is reduced from £10 million to £1 million with immediate effect for disposal on or after 11 March 2020 (Budget Day). Disposals prior to Budget day that qualified for entrepreneurs’ relief count towards the new £1 million limit, and where this has already been reached, the relief will not be forthcoming on future disposals, even if the qualifying conditions are met.

Anti-forestalling

Anti-forestalling measures were announced which may negate protective action taken ahead of the Budget in an attempt to preserve availability of the relief as it applied at that time.

Where arrangements were entered into before Budget day, the old £10 million lifetime limit will only apply if:

  • the parties to the contract are able to demonstrate that they did not enter into the contract for the purposes of obtaining a tax advantage by virtue of the capital gains tax rules setting the contract date as the date of the disposal; and
  • where the parties to the contract are connected, the contract was entered into for wholly commercial reasons.

If the above conditions are not met, the reduced lifetime allowance of £1 million applies.

Anti-forestalling rules also apply in certain circumstances where between 6 April 2019 and 11 March 2020, shares were exchanged for those in another company, and both companies are owned or controlled by substantially the same person.

Plan ahead

If you are planning on disposing of business assets or shares in a personal company, it is important to plan ahead to maximise relief. We can help you. Remember, spouses and civil partners each have their own lifetime limit.

Guidance on the changes is available on the Gov.uk website.

March 16, 2020

Using capital losses

Using capital losses

Where capital gains tax would be payable on a gain made on the disposal of an asset, if the disposal results in a loss, the loss is an allowable loss for capital gains tax purposes.

Gains in the same tax year

In the event that capital gains are made in the same tax year as an allowable loss, the loss is first set against those gains. This may mean that the annual exempt amount is lost as this is set against net gains for the tax year (chargeable gains less allowable losses).

Carry forward unused losses

If there are no gains in the tax year, or allowable losses exceed chargeable gains, the unused losses can be carried forward to a future tax year.

There is no requirement to use them against the first available chargeable gains; rather you can choose when to use them. And unlike the set-off against gains of the same year, they can be set against net gains to the extent that they exceed the annual exempt amount, so that this is not wasted. Any losses remaining unused can be carried forward to a future tax year.

Report the loss

Remember to report capital losses to HMRC. This can be done on your tax return, or by writing to HMRC if you do not need to complete a tax return. You have four years from the end of the tax year in which to claim your losses. We can help you plan your disposals in a tax-efficient manner.

February 7, 2020

Personal allowances – use them or lose them

Personal allowances – use them or lose them

With the end of the 2019/20 tax year approaching, now is a good time to review your available personal allowances for 2019/20 and make sure that they are not wasted.

Personal allowance

For 2019/20, the personal allowance is £12,500. However, where income is more than £100,000, the allowance is reduced by £1 for every £2 by which income exceeds £100,000. This means that individuals with income of £125,000 or more in 2019/20 do not have a personal allowance. If your income is between £100,000 and £125,000, you will receive a reduced personal allowance.

At the lower end of the income scale, if you are married or in a civil partnership and if you are not able to use all of your personal allowance or your partner is unable to use all of their personal allowance, you can claim the marriage allowance. This works by allowing the person who is unable to use all of their allowance to transfer 10% of their personal allowance — £1,250 for 2019/20 – to their spouse or civil partner. However, this is only allowed if the recipient is a basic rate taxpayer. The marriage allowance is worth £250 to a couple for 2019/20. It can be claimed online.

At the other end of the scale, taxpayers whose income exceeds £100,000 could consider taking steps to reduce their income to below £100,000 to preserve their full personal allowance. Options include making pension contributions or gift aid donations or delaying taking salary or dividends until after 5 April 2020.

Dividend allowance

All individuals, regardless of the rate at which they pay tax, are entitled to a dividend allowance of £2,000 for 2019/20. In a family company scenario, where family members have not yet used their allowance, paying dividends by 5 April 2020 to mop up the allowances can be a tax-efficient way to extract profits. The use of an alphabet share structure will enable dividends to be tailored to the circumstances of the recipient.

Pensions annual allowance

Making contributions to a registered pension scheme can be tax efficient. You can make pension contributions to the higher of 100% of your earnings and £3,600 (gross), as long as you have sufficient annual allowance available. The annual allowance is set at £40,000 for 2019/20, but is reduced for high earners. If you have already accessed a money purchase pension, you have a reduced allowance of £4,000.

The annual allowance can be carried forwarded for up to three years. However, before using brought forward allowances (earliest year first), you must use the allowance for the current year. Any allowances unused for 2016/17 will be lost if they are not used by 5 April 2020.

Capital gains tax annual exempt amount

Capital gains tax is only payable where net gains and losses for the tax year exceed the annual exempt amount. This is set at £12,000 for 2019/20. Spouses and civil partners have their own annual exempt amount.

Where a disposal is on the cards which will give rise to a capital gain, if the annual exempt amount for 2019/20 has not been used up yet, consider making the disposal before 6 April 2020 to utilise this. Remember, where a spouse or civil partner has an unused exempt amount, assets can be transferred between them on a no gain/no loss basis, making it possible to make use of their annual exempt amount too.

Inheritance tax annual exemption

The inheritance tax annual exemption allows you to give away £3,000 each year without the gift counting as part of your estate for inheritance tax purposes. If it is not used, it can be carried forward to the next tax year, but is then lost. If you do not use your exemption for 2018/19 by 5 April 2020, you will lose it. There are also various other gifts that you can make IHT-free each tax year.

Act now

Why not speak to us to find out what action you need to take to make sure your allowances are not wasted.

February 3, 2020