Unfortunately, the answer to this question isn’t as straightforward as you might think. The way in which it makes the most sense for you to take money out of your company may not be the same for another business. Consideration must be given to many factors, including the personal federal and provincial/territorial tax rates where you live, the corporate federal and provincial/territorial tax rates where your business is located, your cash requirements both in the short- and long-term, and whether your company had certain favourable income tax attributes that can be leveraged to minimize tax.
Indeed setting up a business is far from straightforward. As well as all the hard work and time it takes to build up and manage a profitable company, there are also a lot of risks for business owners. During the start-up years, you may have forgone paying yourself in favour of reinvesting in your business and growing your enterprise.
Maybe you are now at a point where your business has become more established and you are ready to start withdrawing some of the profits out of your corporation. Maybe you are looking to bolster your personal cash flow for lifestyle reasons or to fulfill your family’s financial obligations.
Or instead, perhaps you are concerned about maintaining your corporation’s status as a small business corporation for the purpose of one day claiming the capital gains exemption. But irrespective of the reason, simply withdrawing cash from your business’ bank account will likely result in a significant tax bill. So you will have to find the tax efficient way that suits your needs and business.
In the United Kingdom, there is a 12.5 percent corporation tax which is applied to all ‘active’ income. This is the income generated from the day to day trading within the business. There is a 25 percent corporation tax levied on any income for ‘non-active’ income.
This can be income generated from rental properties or investments. Also note there is a reduced 6.25 percent corporation tax relating to profits generated from a usable qualifying asset created from Research and Development (R&D) activities.
Have it in mind that any income you take from the company will be taxed at source under the PAYE system (income tax, PRSI & USC). A director is also noted as a ‘chargeable person’ for income tax purposes and is mandated by law to submit a director’s income tax return each year.
Directors are also expected to comply with the ‘self-assessment’ regime which entails that they may be required to make payments on account to meet their preliminary tax requirements. If these payments are not made by the due date, the director will be exposed to ‘statutory interest’ which is calculated at a rate of approximately 8 percent per annum.
However, there are some exceptions to this rule. Non-proprietary directors (directors who own less than 15 percent of the share capital), as well as unpaid directors, are excluded from the obligation to file an annual income tax return.
What is the Most Tax Efficient Way to Take Money Out of a Company?
There are a few different ways to extract cash from your company, and the method which you choose will depend on your circumstances. To make the process simple and easy, here is a breakdown of tactics business owners can use to extract profit from their business, while keeping one eye on your taxes at all times.
Note that to achieve maximum tax efficiency, it is imperative for directors to take a minimum salary. For directors, the first £12,500 is Income Tax-free as of April 2019 – and after this, you’ll pay 20 percent on any salary between £12,501 to £50,000, 40 percent on any salary between £50,001 and £150,000, and an eye-watering 45 percent on any salary that exceeds this.
Note that by keeping your salary just above the threshold of qualifying for a state pension, while keeping within a minimum tax bracket, you can get the most benefit from your wage. One of the most obvious and appealing ways to extract profit from your company is to pay yourself a bonus. When it comes to benefits, this will more or less depend on whether you are receiving a cash or non-cash bonus.
If your bonus is paid in cash or anything that can be exchanged for cash (like vouchers), this will be counted as earnings and will be subject to both PAYE and employee and employer NICs. For non-cash bonuses, the amount of tax will be dependent on the item in question.
When it comes to saving for retirement, you could see some immediate benefit from pension contributions – as this is one way to extract cash from your company while still benefiting from tax relief. Be it an individual or the company itself who pays into the pension fund, have it in mind that this money isn’t treated as a benefit – meaning its very tax efficient.
In the UK, annual allowance of £40,000 exists for pension contributions, which is the limit on what can be paid into an individual’s pension each tax year. But this is reduced for any person with an annual income which exceeds £150,000. Note that personal pension contributions are restricted to no more than 100 percent of an individual’s relevant earnings, meaning they need to be carefully considered when using some of the other strategies in this article.
Also remember that any pension contributions made by the company (rather than the individual) reduce the business’s overall profit, meaning the amount of Corporation Tax is also reduced. Nonetheless, should the employer’s contribution go over the employee’s respective annual allowance, the employee will be liable to pay tax on the excess.
When withdrawing from your pension pot, the first 25 percent is tax-free – after this, any withdrawals will be taxed at your tax rate at the time, which is generally lower than at the time of paying into the scheme. Both a short-term way of extracting profit and a long-term way of planning for retirement, paying into a pension is a wonderful way to make the most of your business’s income.
Dividends can be paid to anyone who owns shares in a company – as long as the company is making enough profit to cover these payments. Introduced in April 2020, a shareholder can receive up to £2,000 in any tax year before paying tax – and after this, any further payments will be taxed based on the tax bands below.
Also have it in mind that dividends are added on top of other income – so if a dividend takes someone into the next tax band, it may be the case that the dividend is taxed (partially, perhaps) at a higher dividend tax rate.
Meanwhile, the tax advantages of being paid dividends are twofold: firstly, they are exempt from National Insurance Contributions and secondly, they are discretionary – which means they can be tailored to individual needs, subject to the company being able to afford to pay them.
Private investments are an opportunity to put your money to another business – helping early-stage companies to reach their next stage of growth. With these opportunities to invest your money in a private company that interests you both personally and professionally, you can invest your profits into a business you care about. Note that investing in a private company means you can be involved from the early stages of a company’s life and make a tangible difference to its development.
With the potential for EIS or SEIS eligibility, you may also be able to reap the rewards of great tax benefits, such as 30 percent (EIS) or 50 percent (SEIS) of the value as a tax credit in the year the investment is made. For business owners looking to explore their profit extraction options and reduce their tax bill, these avenues will help get you started.
With so many varying options available, it is not always easy to know the best way to take cash out of your company. Many business owners and directors find that paying themselves a combination of salary and dividends is the most tax efficient way of operating. This will depend on your business and your personal needs. Using a dedicated accountant can take the stress of tax planning away, as we can suggest a tailored salary and dividend combination to withdraw from your company.