Your company started small but is now making fair profits. However, you don’t need to draw this out as you have enough other income. So is it better to take out the profit now or leave it to accumulate?
Spend or save
Under the current rules the two most tax-efficient methods of extracting profit from your company are to draw it as dividends or let it accumulate until you sell or wind up the business. If you need the profit from your company as income to live off, the second option is academic. But if that’s not the situation, what is the most tax-efficient strategy to employ?
Tax on dividends – 2014/15
The income tax payable on dividends ranges from nothing to 30.55% of the amount you receive. The first step in working out the tax is to increase the dividend by 1/9th, e.g. for a dividend of £2,700 the taxable amount is £3,000. The next step is to add the taxable amount to your other income. Then, where your total income for 2014/15, including the taxable dividends is:
- no more than £41,965, there’ll be no tax for you to pay on them
- between £41,965 and £150,000, the rate of tax on the dividends falling between these amounts is 25%
- over £150,000, the rate of tax on dividends falling above this is 30.55%.
Tax on accumulated profit
Where you sell or wind up your company, except if it’s an investment company, the rate of tax you’ll pay on accumulated profits is just 10% capital gains tax (CGT). This is known as the entrepreneurs’ relief rate.
Income tax v CGT
On the one hand, income tax as a percentage of the dividends you draw will be between zero and 30.55%, while the tax on accumulated profit left in the company will be just 10% CGT.
It theory, the strategy is simple. Draw profit out as dividends up to the limit at which no income tax is payable, otherwise accumulate it until the company is sold or wound up.
Tip 1. Where the amount of your other income, i.e. everything but the dividends, is uncertain, don’t draw any until March. At that time make your best estimate of income and take dividends accordingly to stay within the nil rate tax band.
Tip 2. Alternatively, draw the dividends during the year. In March if you think your income is above the nil rate tax band (£41,450 for 2014/15), pay a pension contribution. This raises the limit at which income tax starts to be payable on dividends.