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Tax planning update: profit extraction

One of the perennial challenges in taxation is how to get money out of your company tax-efficiently. The usual ways are:

Payment of remuneration – tax deductible for the company but taxable at up to 40% on the director and subject to NIC. Overall rate of tax and NIC around 48%

Payment of dividend – not subject to NIC, taxable at an effective 25% on the shareholder but not tax deductible for the company. Overall rate of tax 40% - 47% depending on the level of profit in the company.

Making a loan – again, no tax relief for the company: and there is not only an annual Income Tax charge on the “benefit in kind” but also (usually) an obligation for the company to deposit with HMRC an amount equal to 25% of the amount loaned, which is repayable only when the loan is repaid.

We are seeing an increasing number of schemes promoted by specialist providers which promise more tax-efficient ways to extract value from companies. Some of our clients may even have been contacted directly by these specialist firms. The key question is – do they work and do we recommend them?

Well, the good news is that these are not (usually – there are some dishonourable exceptions) the sort of highly artificial scheme which HMRC have vowed to stamp out. Broadly, the kernel of most of these schemes is that a company establishes a trust for the benefit of some or all of the employees. It then makes a contribution to the trust. In most cases it is accepted that the company does not get tax relief at the time the contribution is made (though there are some more aggressive schemes which do seek to obtain relief). On the other hand there is no tax charge on any employee at the time the contribution is made. Typically, the funds in the trust will then either be invested in a separate sub-fund for each director or may be loaned to the director. A benefit in kind charge normally arises on any such loan; but that is the only tax charge at this point. There are also Inheritance Tax advantages to the arrangement.

Although the strategies are not without risk and sometimes are in danger of being oversold as the solution to every problem, they may be of interest where a company has cash which the director wants or needs to access and for example:

A director or shareholder wants to move house and would otherwise borrow from a third party (why borrow from a commercial lender when you can borrow from yourself?); or
A director or shareholder is borrowing to meet one-off expenditure which he wants to spread over a period (like weddings or possibly school fees); or
Short term cashflow means that cutting this year’s tax bill is supremely important; or
You are intending to use the money in such a way that the interest would be tax-deductible so no benefit in kind arises (eg. to acquire property for letting or to fund a sole trade or partnership business); or
The IHT advantage is important (for example the schemes may unlock a form of “death-bed” planning whereby value could be removed from a property investment company and put outside the estate of the owner)

For more on these strategies please contact your normal contact partner.