How the profit can be extracted from Ltd company formation UK in a tax efficient way and strategies for minimisation of group tax?


There exist various methods through which profits are extracted from a company. These methods, along with dividends, remuneration, payments of dividends, liquidation, loans from close companies, rental income and pension provision are discussed in this blog. The second part of the blog discusses the strategies required to minimize the group tax.

After ltd company formation UK a careful consideration is required for choosing the level and method of extraction of the profits when trading activities are carried out. This decision should take into consideration both the needs of the directors and the shareholders and also the needs of the formation itself after company registration United Kingdom.

As an example, consider that after the UK company formation with bank account, it may be required that the retaining of a specific profit level is carried out to lessen its bank overdraft or make the funding of an expansion project.

A comparison of various methods of extraction is given below. These methods include remuneration, dividends, loan interest, rental income and contributions of pension. A summed up version is provided in the table below:

Extraction Method

Individual

Company

Remuneration

Benefits

Salary

Benefits free from Tax

Taxable

Taxable/Class 1 NICs

Tax/NI free

Deductible/Class 1A NICs

Deductible/Class 1 NICs

Deductible/No NICs

Dividends

No tax payment required from the taxpayer at basic rate

Additional rate at 37.5% and higher rate tax at 32.5%, reduced by 10% credit of tax

No NICs

Not deductible

Interest on Loan

Taxable in the form of savings income

Deductible on the basis of accruals in the form of interest on a relationship of loan

Income Acquired from Rents

Non-savings income liable to tax

Deductible

Contributions of Pension

To registered schemes of pension

Free from Tax

Deductible

Remuneration or Dividends

The shareholders or director may want to extract their profits either as remuneration or dividend. The retained profits of a UK company formation with bank account will be reduced by the payments of remuneration or dividends which means a reduction in the total value of asset and hence the shares’ value, resulting in the reduction of any chargeable gain on the disposal of those shares. However, the immediate cost of tax for the payment of remuneration or dividends should be weighed against this benefit.

Once set up limited company companies house, there is a need to calculate the total profits of the company for which the cost of benefits and remuneration will be allowed. This decision to make such payments or not, can have an effect on the rate of corporation tax by reducing the level of profits. However, the cost of national insurance should also be kept in mind. Best result can be obtained by the combination of remuneration and dividends.

Payments of Dividend

Timing can be important if the payment of dividends has been made. The year of tax in which a dividend gets paid has an effect on the due date for any additional tax, and if another income of a shareholder fluctuates, it may determine if there is a need of payment of any additional tax. Higher rate payers of tax should make the payment of tax at 32.5% on dividend income and additional rate payers of tax should make the payment at 37.5%, subject to a credit of tax of 10%.

Dividends carry a credit of tax of 10% and their taxation is done only at 10% in the hands of basic rate taxpayers which means that dividends are attractive for such individuals. However, the 10% credit of tax cannot be repaid to the individuals who do not pay tax.

Flexibility is allowed for the payment of dividends, i.e. the family members do not have to work necessarily in order to acquire a dividend. However, the weightage of this must be checked against the fact that the company should generate enough profit for the payment of dividend. Moreover, HMRC may invoke anti-avoidance legislation if the payment of dividends is made to non-working family members if those who do work for the company do not acquire a commercial salary. Regular dividends from an owner managed company will be recognized by most banks and building societies as income for mortgage or other purposes of loan. This allows the taking away of a potential disadvantage of funds extraction in the form of investment income.

The dividends do not allow the payment of pension contributions and are not subject to NICs while remuneration and benefits do allow for the payment of pension contributions. For the company, they are not an allowable expense of trading.

Liquidation – An Alternative to Dividends and Remuneration

A substitute to both the remuneration and dividends is to retain the profits within the company and then perform its liquidation. On the sale of its assets, the company itself may have capital gains and the shareholders will have capital gains on liquidation that will be considered as a disposal of their shares for the amounts whose payment is made to them. The charges of CGT on the shareholders may be subject to mitigation by spreading the distributions of capital over two years of tax, so as to make use of annual exempt amounts for both the years. The relief of entrepreneur may be available, and in this case, the CGT rate will be 10%.

The consideration of this route may be worth it when a company is set up to initiate a single project that will reach its completion within a few years.

Loans and Interest Income

A shareholder or a director may want to lend money to the company and in return, extract profits as income of interest.

The taxation of income of interest is done on the director or the shareholder in the form of a savings income but it is not subject to NIC. For the purposes of pension, it does not count as relevant earnings.

From the perspective of a company, the relief for tax in case of the interest will be available according to the rules of loan relationship, i.e. either as a deficit on non-trading relationship of loan or a trading expense.

Loans to Participators by Close Companies

Although loans to participators by close companies are not considered as distributions. On making such a loan, the company suffers with a charge of tax: a payment equivalent to the loan amount * 25% is made to the HM Revenue and Customs.

The recovery of this charge of tax cannot be done until the loan is written off or repaid.

Income from Rent

The owners may make a decision to retain the premises of business outside the company and charge rent for its usage upon incorporation. The benefits of this method of extraction of profit are that the company will get a deduction of trading income for the rent charged up to a commercial rate. Also, the payment of any NIC is not required.

It also has a disadvantage that the income from a property business does not qualify as relevant income for the purposes of pension. The rental income payment will also contain the relief of entrepreneur on subsequent premises disposal.

In the case of many small companies, own homes of the directors are often used for the business of company. It is possible to make a claim of a deduction in the company for reasonable rent whose payment is made by the company. It should be taken care of the fact that the principal private residence relief is not denied on a proportion of the home. To accomplish this, it must be presented that the room or the rooms are not used for the business of company exclusively, i.e. whenever a guest comes to stay occasionally, he/she lives in the ‘study’.

Provision of Pension

In the present era, it is extremely important for a person to make savings for his/her own retirement. It is a fortunate case that this consideration is taken into account by the government and as a result, provision of pension has become the best and most efficient way of the extraction of funds from a family company.

Employers may set up an occupational plan of pension for their employees. Employees may make a contribution to the occupational plan of pension and all the individuals may make a contribution to the personal plan of pension of an employee.

There are certain tax breaks for registered schemes of pension, which are mentioned below:

  • Any NIC is not due on the contributions of employer.
  • Relief of tax is obtained by the employer for the normal contributions whose payment is actually made during the period of accounting.
  • Up to 25% of the fund is available for tax free lump sum.
  • There is no benefit liable to tax for the contributions of the employer.
  • The relief of tax is acquired by the individual on his own contributions.
  • The fund of pension becomes free of tax as the credits of tax on dividends do not need to be paid.

From all the discussion above, we can conclude that after company registration United Kingdom the most efficient method of the withdrawal of profit with respect to tax is dependent upon the marginal rate of the corporation tax whose payment is made by the company. In the case of a small company, the cheapest form of obtaining a profit is that of the dividends. In the case of a company that is either medium sized or large sized, the bonus is considered as the most preferable option making an assumption that the shareholder or the director is already making the payment of maximum class 1 primary NICs.

In case if the succession of the company is expected to be achieved by passing down of the shares in the family, then there will only be an increment in the gain that is to be rolled over by means of a claim of gift relief.

Strategies for Minimising Group Tax

There are various opportunities of tax planning available to the groups of companies. The following points should be taken into consideration:

  • The group can be considered as one unit for the purposes of rollover relief on the business assets replacement.
  • There should be a restriction to the minority interests in order to make sure that the holding company has an effective interest of 75% in every company. This will allow the group relief of the losses to whichever company can make the best use of them specifically the companies in the marginal relief band.
  • VAT will occur on the trade of intra group unless a VAT group is formed. It may be a best choice to have the concentration on all the exempt supplies in one or multiple companies that can be left outside the group of VAT, and zero rated supplies in one or two companies that can be left outside the group of VAT or can form their own distinct group of VAT and can make the claims of monthly repayments.
  • The group members will get an equal share of the small profits limits of rate. The sharing of profits may be done to benefit from them by fixing transfer prices for trading of intra group (rules of transfer pricing are generally not applicable to small and medium sized enterprises). However, minority shareholders might then get a fair advantage or a disadvantage. The number of associated companies in the group should be carefully taken into consideration as setting up an extra subsidiary may have an effect on the rate of tax of all group companies.
  • A group relief cannot be obtained for the capital losses. However, in order to transfer losses and gains between group members, an election can be conducted. It will be beneficial for net gains to be in the company that is making the payment of lowest marginal rate of corporation tax. However, some restrictions are applicable on the usage of pre-entry gains and losses.

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