Hero background
Business Tax, Personal tax, Small Business, Tax Planning, Taxation

How to balance increasing limited company taxes and profit extraction

RJP LLP By RJP LLP
How to balance increasing limited company taxes and profit extraction

In recent years, the government has been slowly eroding the potential tax advantages of operating a small business through a limited company compared with being in ‘traditional’ paid employment or operating as a sole trader. Typical methods of operation of small companies involve the director shareholders taking small salaries, topped up by tax advantaged dividends.

The benefits of operating in this way have however been eroded as a result of the reforms to the dividend tax rates. The formerly available 10% dividend tax credit was removed in April 2016 and dividends became taxable at the rate of 7.5% for basic rate taxpayers. Although a £5,000 dividend allowance also came into operation, this increased tax rate – rising to 32.5% for 40% taxpayers, and 38.1% for 45% taxpayers – means the tax savings achievable have been reduced, in some cases quite significantly.

These changes give rise to two important questions. Firstly, is it in fact tax advantageous to trade through a limited company and secondly, what is the most tax efficient way for a company director/ shareholder to remunerate themselves? Advising on the best ways to tax efficiently extract profits from a limited company has become one of the questions that we, as tax advisers, are most commonly asked by our clients. 

 

Is it still tax efficient to operate as a limited company?

The short answer is yes. Although the tax differential between limited company and sole trader status is narrowing, there are still many advantages to operating within a company structure, not least of which is flexibility. However, the tax advantages vary quite considerably and in some cases, the benefits will be negligible considering the additional administrative and accounting overheads of incorporation.

The following table compares different post tax income levels for the 2017/2018 tax year to illustrate this point and highlights at what point a limited company is the best option.

PROFIT

SOLE TRADER COMPANY DIFFERENCE

20,000

17,087 17,639

552

50,000

37,737 40,116

2,379

100,000

66,737 68,195 1,458
120,000 74,337 79,130

4,793

150,000

91,137 90,788

(349)

250,000

144,137 142,438

(1,699)

500,000 276,637 267,785

(8,852)

 

What other factors should be considered?

Apart from post-tax income there are other significant factors to take into consideration, for example:

  • The positive perception that being a limited company vs sole trader can create in the eyes of commercial stakeholders;
  • The limited liability provided by company status vs being a sole trader, although this can also be achieved by operating through an LLP;
  • The availability of corporate tax reliefs including R&D tax credits and EIS, that are not otherwise available to unincorporated businesses;
  • Flexibility on how and when to remunerate directors and shareholders;
  • Lower tax rates on profits retained and much lower corporation tax rates from 2020.

For businesses involved with innovation, the availability of R&D tax credits for limited companies can be extremely helpful in funding development. A far wider range of companies are now successfully accessing this tax relief than have done so in the past and the regulations have recently been relaxed to also include backdated claims for reimbursed employee expenses.

 

Other methods of profit extraction from limited companies

In addition to taking dividends, there are also other methods of tax efficient profit extraction from companies, such as:

  • Company pension contributions – the most efficient method of fund extraction currently. The shareholder is also able to access flexible draw down and may benefit from lower effective tax rates during retirement. The company may also benefit from additional R&D tax relief at the enhanced rates;
  • Loan interest – if a director has surplus personal savings it may be possible to loan an amount to the company and receive interest payments from the company;
  • Rental payments on privately owned commercial property – although this is an efficient method of fund extraction, it can have implications for entrepreneurs’ relief and this needs to be planned for well in advance of a disposal.

Through careful tax planning it can be possible for a single company director to draw up to £22,500 in tax free income during the 2017/18 tax year, using a range of tax reliefs and allowances available. For example, by taking a small salary to the value of the NIC threshold, which is currently £8,164 p.a., interest to utilise the remaining personal allowance, the £5,000 savings and basic rate allowance, plus £5,000 in dividends to utilise the dividends allowance too. Where appropriate and legitimate to do so, it may also be possible to involve spouses and adult children in a limited company, and in doing so, utilise their own tax allowances too.

In summary, the introduction of the new dividend allowance and increased dividend tax rates has meant that the vast majority of limited company owner directors are now facing slightly higher tax bills. However, there are also many more corporate tax reliefs available to potentially benefit from. In most cases, incorporation, or remaining incorporated, is still worth the slightly higher tax bill and by working in partnership with your tax adviser it’s possible to identify acceptable ways to limit total tax liabilities.

If you would like to review your financial affairs and discuss tax planning opportunities with us in detail please contact Lesley Stalker by emailing partners@rjp.co.uk.

How to get onboard with RJP
1
Talk to us
Have an initial discussion with a member of the RJP team to identify ways we can enhance your business's growth with our comprehensive support and strategic advice.
2
Hassle-free migration
Choose RJP and we'll smoothly manage all transitions, handling paperwork, coordinating with your current accountant, and ensuring no deadlines are missed for a worry-free experience.
3
A pathway to growth
Finally, we will send you the required documents to sign and return, leaving you to continue leading your business, backed by our abundant, responsive advice and support.
Here’s what our clients have to say
Hear directly from our clients about how RJP's personal, straightforward approach has made all the difference in their business and personal success.
"I just wanted to drop you a short note to say how grateful I am for the support that RJP has provided over the past 4 weeks while our Financial Controller was away. I struggle to comprehend how much work your staff get through during their weekly visits and they are always a pleasure to have around the office."
"I wanted to write and express our gratitude for your help and hard work in getting Probate through and settling all the taxes. I am so pleased that we selected RJP, as your professional help and updates throughout this process have been invaluable. If at any time in the future Probate assessment may be needed, you will be our first port of call. Once again, many thanks to the whole team."
"I would like to take this opportunity to thank you very much for the amazing job you have done navigating us through this whole process. My family and I also really appreciate the care and compassion demonstrated by you and your team in every dealing. Our thanks to everyone."
"Just a quick e-mail from me to thank you for achieving the target for producing the draft accounts – it is very much appreciated and gives a first class impression of your firm. Many thanks."
"RJP provide our company with a complete service which takes the stress and strain away from the day to day running of our accounts! Their understanding of our business and their patience and advice is invaluable."
cta background
Get the latest tax tips to your inbox every month


    faq background
    FAQs
    What services can RJP offer to help me understand how my business is truly performing?
    At RJP, we understand that keeping a finger on the pulse of your business's health is crucial. That's why we offer management reporting services—think of them as a regular health check for your company. These insights show you the real-time performance of your business, helping you make informed decisions to nurture and grow your enterprise.
    I'm keen to expand my business. How can RJP help me with that?
    We love seeing your business flourish! Growth and improvement are at the heart of our practical advice. From the ins and outs of everyday operations to big-picture strategic moves, we're here to offer clear, actionable steps that can propel your business forward.
    Audits and compliance can be a headache. How does RJP ease this process for business owners?
    We know dealing with the issue of compliance and auditing can be less than thrilling. That's exactly why we're here—to handle the complex stuff so you don't have to. We offer comprehensive compliance services, ensuring everything is up-to-date without you having to wade through a sea of regulations.
    I've heard about tax relief schemes but don’t know where to start - can RJP guide me?
    Absolutely! There's a world of opportunity out there to support your business financially, and we're well-equipped to be your guide. We can help you understand and access HMRC’s tax relief schemes that are relevant to you and your business, making sure you're not missing out on any potential benefits.
    If I have a question or need support, how responsive is RJP to my needs?
    When you need us, we're just a call or an email away—no question is too small or too large. We're known for our quick responses and our fixed fees mean you can reach out without worrying about unexpected costs. Plus, we always keep things simple and straight to the point. We're not just your accountants; we're part of your team, ready to support both your business and personal needs.