Tax Efficient Ways to Extract Cash from Your Business

Extract Cash

In the last few weeks I have been inundated with enquiries as the changes being made to the taxation of dividends hits home for many business owners.
Just to remind you of the changes being implemented, as of 6 April 2016 the dividend tax credit is being replaced by a £5,000 tax-free dividend allowance. Sums above this will now be taxed according to the following rates:

2016/17

2015/16

Basic Rate

7.5%

0%

Higher Rate

32.5%

25%

Additional Rate

38.1%

30.6%

If we look rationally, in the majority of circumstances business owners are still better off taking dividends rather than a full salary, as the tax is still significantly lower. However, there are ways in which you can mitigate the amount of tax you pay, this needs to be looked at in two ways: 1. What can you do pre April 2016 and 2. What can be done post April 2016.

1. What can be done pre 6 April 2016
If your business has the available funds, then one short term solution is to extract more money from your company this financial year in order to take advantage of the lower tax rates. This can be done by simply paying yourself a larger dividend before 5 April 2016. Although, if you pick this option you must ensure you set aside enough money to cover the additional tax in your 2016/17 return. Another option is to:

  • Pay yourself a dividend;
  • Invest into a series of Enterprise Investment Scheme (EIS) qualifying companies and
  • Use the resultant 30% income tax credit from the investment to offset the vast majority/all of the income tax payable on the dividend (at effective rates of 30.56% or 25% respectively, depending upon whether you are a higher or additional rate tax payer)

If you were to consider this option, the table below shows the figures involved for a higher rate tax payer:

2015/16

2016/17

Difference

Dividend – £

100,000

100,000

Effective rate of tax

25%

32.5%

7.5%

Tax – £

25,000

32,500

7,500

Net cash extracted – £

75,000

67,500

7,500

EIS investment required to reduce to nil, i.e. tax/30%  – £

83,333

108,333

25,000

As you can see this is a great option for those that have the available funds, as despite the cost of withdrawing a dividend being far greater in 2016/17, it is still possible to reduce the tax payable on the dividend to zero if enough money is invested. The idea is then to leave the investment in the EIS for at least three years and then look to relinquish your investment back. It is therefore important to invest in very low risk companies where your initial investment is not at risk. I am happy to discuss this option in more detail for anyone that is interested.

2. Post 6 April 2016
After April 2016, in order to ensure you have a tax efficient remuneration structure in place it is going to be even more important that you review the way in which you withdraw your funds. However, as mentioned before, for the majority of people it is still going to be more efficient to take dividends. For example, if you were to swap your £80,000 dividend for an equivalent salary you would receive a net of £62,925. If you continue to withdraw this as a dividend, your net would be £71,013.
However, there are a few ways in which you can potentially mitigate your tax liability. These involve altering and diverting the way in which you withdraw cash from your company. Some potential options are:

  • Increase your pension contributions and benefit from the 25% tax free withdrawal if you are over 55 years old
  • Bring in family members to utilise their basic rate
  • Create trusts to pay care home, university or school fees and reduce the higher rate tax on the dividend
  • Add interest to a shareholder loan

Every company is different. Therefore, it is impossible for me to give one solution that suits all, all I can do is recommend that you review the way in which you withdraw money from your business, run the numbers and see if you can benefit from one of the above options.

If you would like advice on your personal circumstances, please contact me at lee@raffingers.co.uk and I will be happy to talk through your options.