All shareholders and directors in privately-owned companies have an interest in how they extract value from their company.
Most owner‐managers are broadly aware that there are alternative methods, with differing commercial and taxation consequences, but few owners appreciate just how wide‐ranging the options can be.
Challenging though it can sometimes be, planning to minimise taxation liabilities on value which is drawn out of your company can yield exceptional savings, accessed year in, year out, over a long period of time.
Harold Sharp’s Tax Advisory practice puts planning (and maintenance) in this “value extraction” arena under the following four different headings:
Dealing with your monthly “income“ needs
Bread and butter extraction planning typically revolves around the best methods available to pay shareholder‐directors, having all due regard to things like: tax rates for different income sources, National Insurance (NI), the dividend Nil Rate Band, and exemptions for specific benefits in kind.
Threshold wage arrangements
Many will be familiar with the merits of the “threshold wage”, supplemented by NI‐free dividend income, for a tax efficient annual outcome. In practice, however, it is surprising how many businesses are either not familiar with that arrangement, or are being advised to operate it incorrectly:
- How often do we see the “threshold” set higher than it needs to be for Income Tax purposes, with annual wastage of Class 1 NI (both employer’s and employee’s) arising wholly unnecessarily?
- how often do we see dividends drawn, oblivious to taxable employment income still taken in the form of car and other taxable benefits?
The “threshold wage” arrangement warrants care, attention and maintenance to yield a constantly efficient outcome which, over the medium and long terms, can make a very significant difference.
Sources superior to dividends
The “threshold wage” arrangement is often assumed to be the optimal method of taking an owner’s monthly income.
This is frequently not the case and, with planning and awareness, many are able to take advantage of superior options, like:
- rental income, where the owner(s) holds property used by the limited company, yielding NIfree income which is taxed at rates not subject to the dividend tax “premium”; or
- interest, where an NI exemption again dovetails with Income Tax rates which do not suffer the “premium” rate associated with dividend income.
More shareholders should benefit from these sources, due to a regular failure of planning advice from competitor firms who are simply not extraction planning savvy.
Joining your dependents to the plan
We all have reliefs and allowances. Where a company’s owners are providing domestically for others, it is often possible that the reliefs and allowance applicable to those others might be accessed to materially reduce the overall burden of Income Tax. Those principals typically have to extract enough to pay their own way and provide for others.
Handling employment and shareholding arrangements which can involve other family individuals and facilitate the use of more personal allowances, more basic rate bands, etc., can help to save a small fortune of taxation over the course of the owner’s life cycle.
Take, for example, a situation where some shares in the family company are transferred into trust for minor children, put there by the grandparents, perhaps: Dividends paid on these shares and used to fund the often very expensive costs of education and maintenance can access the otherwise wasted reliefs of those minors. Over the course of 20+ years of non‐taxpayer status, the savings achieved from diverting value to these non‐taxpayers can be huge, relieving Mum and Dad of a significant burden which many had assumed they had no choice but to suffer.
Turning income into “capital”
There are junctures and events in an owner’s life when it is possible to design and engineer a major outflow of value from the company, spread over years sometimes, which is taxable on the basis of “capital” (rather than income) and typically subject to zero, 10% or 20% rates of capital taxation (compared to income rates which can exceed 45%).
Succession is just one of those junctures where we are often able to achieve medium or long term extraction of profits from the company as capital payments. Those transfers of money might nevertheless be taken monthly, out of ongoing profits from the business, with large savings which many had no idea could legitimately be done.
Sending value to other places
The extraction of value is not necessarily about getting money into the bank account of the owner. Sometimes the extraction of value is wanted in “kind” (with non‐taxable benefit opportunities achievable along the way), and sometimes it involves moving value into other vehicles (like pension funds, investment companies, trust arrangements, etc.) which does not then need to involve any leakage of taxation at all, if designed and implemented correctly.
There is a lot within the overall subject of extracting value from the privately‐owned company. Large variations in commercial and taxation consequences can accrue to different solutions. Learning what your options are, and putting in place those arrangements early on, can be long‐term advantageous with significant cumulative value retention, as a result.
If you have any questions please speak to Tax Partner Chris Barrington or your usual relationship principal, or call us on 0161 905 1616.