Tax Efficient Extraction of Profits

In is Summer Budget, the Chancellor announced far-reaching reforms to the way in which dividends are taxed. If you are the director of a personal or family company and extract profits in the form of dividends, this will affect you.

Under the rules as they currently stand, it is preferable from a tax and National Insurance perspective to operate as a limited company and to take a small salary to preserve entitlement to the state pension and certain contributory benefits and to withdraw additional profits in the form of dividends. Although dividends must be paid out of after-tax profits (once corporation tax has been paid), withdrawing profits as dividends has a number of advantages:

– no National Insurance contributions are payable on dividends; and

– the availability of the 10 per cent tax credit attaching to dividends means that there is no further tax to pay until total income reaches the threshold at which higher rate tax becomes payable (£42,385 for 2015/16). Thereafter, the effective rate of tax on the net dividend is 25% for a higher rate taxpayer and 30.6% for an additional rate taxpayer.

What is changing? From 6th April 2016 the 10% tax credit on dividends is being abolished. This means that it will no longer be necessary to gross up the amount of dividend actually paid to take account of this tax credit or to deduct the tax credit from the tax that you owe – the amount paid by your company will from 6 April 2016 be the gross amount of the dividend.

To compensate for this loss of tax credit, a new tax-free allowance of £5,000 will be available for dividends. Once this allowance has been used up, dividend income will be taxed at the appropriate dividend tax rate, which will be 7.5% for a basic rate taxpayer, 32.5% for a higher rate tax payer and 38.1% for an additional rate taxpayer.

This means that anyone whose dividends are taxed at the basic rate and who, once the personal allowance has been used up, has dividend income of more than £5,000 a year will pay more tax on their dividends from April 2016. It will no longer be possible to pay a small salary (covered by personal allowance) and to then pay dividends until the higher rate threshold is reached without having to pay any further tax on those dividends. It will also be necessary to ensure funds are available to pay the additional tax that will be due on the dividend.

It is advisable to speak to your tax adviser as to how these changes will affect you and to discuss your optimal profit extraction strategy going forward. Although the new dividend rules do not come into force until 2016/17, it is also advisable to review your dividend extraction strategy for 2015/16 as it may be beneficial to accelerate dividend payments to before 6 April 2016 to take advantage of the more favourable dividend tax rates applying before that date.

One-man companies to lose employment allowance It should also be noted that the National Insurance employment allowance will not be available to companies where the director is the sole employee from 6 April 2016 onwards. For personal companies this will affect the optimal salary level and impact on the profit extraction strategy.

Is a limited company still the best option? You may also wish to consider whether operating through a limited company remains the best option for you. However, before making a decision you may wish to see what the Chancellor does to Class 4 National Insurance Contributions, which are payable by the self-employed on their profits. At the time of the March 2015 Budget the Chancellor announced his intention to consult on the abolition of Class 2 National Insurance contributions and the reform of Class 4 contributions to provide benefit entitlement. The consultation is expected later in the year. However, it should be noted that as things currently stand, disincorporation relief, which allows a company to transfer assets to its shareholders without triggering a tax charge, is only available where the transfer of assets occurs before 31 March 2018. If you are thinking of disincorporating, you may wish to do so before that date.

Autumn Statement

Autumn Statement

In his Autumn Statement to Parliament at the beginning of December, the Chancellor of the Exchequer said that the law will be changed, so that ‘when someone dies, their husband or wife will be able to inherit their ISA and keep its tax free status’. The official briefing papers explained that this will apply where the ISA holder dies on or after 3 December 2014. His or her wife, husband or civil partner will be allocated an additional ISA investment allowance equal to the value of the savings in the deceased’s ISA account. This can then be used by the surviving spouse to transfer the inherited investments into an ISA account in his or her own name.

It will not be possible to make the reinvestment in the surviving spouse’s ISA until 6 April 2015. Later this year, additional legislation will preserve the tax free status of the original ISA investments during the administration of the estate.

There was also some good news for employers of personal carers. From 6 April 2015, they will qualify for the ’employment allowance’, which means they will be exempt from the first £2,000 of employer’s National Insurance contributions otherwise payable each year. The carer him-or herself will continue to pay employee’s contributions in the normal way.

HMRC have emphasised that the relief applies only to carers employed to look after people requiring care because of disability, frailty, injury or illness. It will not apply, for example, to families employing a nanny to look after healthy children.

The Chancellor also announced ‘Government-backed student loans of up to £10,000 [for] all young people undertaking postgraduate masters degrees’. These loans will be available from the 2016/17 academic year, for students under 30 undertaking ‘a post-graduate taught masters course’. Subject to consultation, they will be repayable (with interest at RPI + 3%) at 9% of income over £21,000. These repayments will have to be made in addition to any undergraduate loan repayments – so potentially a total of 18% of gross earnings.

RTI late filing penalties from October

Employers should be aware that automatic penalties will apply if their RTI submissions are not up to date by Sunday 5 October 2014 – and thereafter kept up to date. These penalties will be in addition to the automatic interest charge which has applied to late payments since April this year. Penalties will be imposed:

– Where a Full Payment Submission (FPS) is filled late – that is to say, is not filed by the day the employees are paid or, if the employer qualifies for the concession for some employers with nine or fewer employees, by the last pay day in the tax month; and

– Where an employer fails to file a nil Employer Payment Summary (EPS) – for a month in which no payments to employees were made – by the 19th day of the following month (so by 19 October for the tax month to 5 October).

The monthly penalty will be £100 if the employer has less than ten employees; £200 if he has between 10 and 49; £300 if he has between 50 and 249; and £400 if he has 250 employees or more. However, the first default each tax year will be ignored.

Penalty notices will only be issued every three months. It appears that the first penalty notices will be issued in October 2014, to cover any defaults for the current tax year that were not rectified by Sunday, 5 October.

Where a submission is three months late, HMRC will additionally be able to impose a 5% surcharge on the tax and National Insurance contributions payable. They say that this will be used ‘only for the most serious and persistent failures.’

From April next year, the screw will be tightened yet further, with the existing penalties for late payment of monthly or quarterly PAYE remittances being made automatic and applied in all cases. The penalty will be between 1% and 4% of the tax due, depending on how many times, in the tax year, the employer pays late.


No cap on pension fund withdrawals

When is £250,000 worth only £176,782?

The answer, unfortunately, is when you take it out of your pension fund. The headline announcement in last month’s Budget was that, from April next year, people aged 55 or more will be able to withdraw as much as they like, whenever they like, from their Personal Pension Plans and similar arrangements. However, the catch is that, while the time-honoured rule will remain, that a quarter of the fund may be taken as a tax free lump sum, anything more will be taxed as income of the year in which it is taken.

For example, suppose an individual has a pension fund of £250,000 and no income other than the National Insurance pension of (say) £6,000 a year. He or she might decide that a good plan would be to withdraw the whole fund, use £200,000 to purchase a buy-to-let property to provide an income for life and a worthwhile inheritance for the children, and keep £50,000 on deposit for contingencies. However, if the whole pension fund is withdrawn as a single lump sum, the income tax charged (at 2015/16 rates) will be £73,218, leaving the individual with only £176,782 of his or her original £250,000. This is because nearly two-thirds of the lump sum is taxed at 40% or even 45%.

Spreading the withdrawal over two tax years – with the tax free lump sum taken in the first year, and the balance half in the first and half in the second – would reduce the total tax paid to £58,686, largely because spreading means twice as much would be charged at the basic rate.

Looking at two smaller pension funds, a fund of £100,000 would suffer a tax charge of £21,843 if wholly withdrawn in one year, or £13,686 if withdrawn over two years, while a fund of £50,000 would suffer a charge of £6,483 or £5,700 (in all cases, assuming the only other income was the £6,000 pension).

The bottom line, perhaps, is that pension fund holders should think long and hard before taking a withdrawal which will suffer tax at more than the 20% basic rate. Very broadly speaking this means that, after taking a quarter of the pension fund as the ‘tax free lump sum’, further withdrawals plus pensions and any other income should not exceed about £42,000 in any tax year.

Another point to watch is that the tax charge on money withdrawn from a pension fund is likely to be even higher if the individual has substantial earnings or other income in the tax year he or she makes the withdrawal. If in our first example (of a £250,000 pension fund) the individual had earnings of £30,000 instead of the National Insurance pension of £6,000 (say, because he or she retired towards the end of the tax year and took the maximum withdrawal immediately), the tax charge on that withdrawal would be £80,118, reducing the after-tax sum available to £169,882.

One would hope that the pension provider will warn the investor if he or she applies for a withdrawal which is likely to trigger a significant tax liability. However, it is easy to see how cases might slip through the net, for example where the individual has invested in pension plans with several different providers and the overall scale of the proposed withdrawals is not appreciated.

Don’t waste a valuable guarantee!

Hidden away in the small print of many older pension plans (especially those taken out before about 1990) is the option to take a pension calculated according to a set formula – effectively a guarantee to pay a stated minimum pension. Originally, such guarantees were not particularly generous, but now that interest rates have fallen to historic lows, taking the guaranteed pension may well be an attractive alternative. It will produce a far higher income than could be obtained by buying an annuity on the open market,and provide that income securely for life.

However, because the guaranteed pension is technically an option, it is up to the policyholder to claim it. Moreover, entitlement to the guaranteed pension is almost always conditional upon taking the pension at a fixed date – usually the default retirement date specified by the policy. We would strongly advise anyone with a pension plan to see if it promises a guarantee and, if it does, to make a prominent ‘reminder to self’ of the date by which it must be claimed. A lot of money could be a stake.

Transitional arrangements

As stated in the first paragraph, ‘withdraw as much as you like, when you like’ begins in April 2015. Until then, some of the existing rules are relaxed, to allow higher withdrawals under drawdown plans, and small pension savings to be taken as an immediate lump sum.


Changes to Employer’s National Insurance Contributions

The National Insurance ‘Employment Allowance’, originally announced in the Chancellor’s Spring 2013 Budget, will be launched in April 2014. Essentially it means that a business (or a charity or other voluntary organisation) will be excused payment of the first £2,000 of employer’s National Insurance contributions other due each tax year. This will not affect the contributions payable by employees, or the benefits accruing to them.

The reduction is called ‘the Employment Allowance’ because the Government hopes that it will encourage small firms, especially, to take on more staff. However, a firm will be entitled to the allowance whether or not it takes on new staff. Moreover, even a one-man company will be able to claim the allowance against employer’s contributions due on remuneration paid to the proprietor-director (unless the relevant earnings are caught by IR35 legislation).

A planning point for a small family company is that the shareholder-directors currently often choose to pay themselves salaries under the point at which employer’s NI contributions become payable (£7,696 for 2013/14). However, for 2014/15 it may be better to take a salary equal to the income tax personal allowance (£10,000 for 2014/15) – the point being that every extra pound taken will cost 12p in employee’s NI contributions but save 20p in corporation tax.

The Employment Allowance will not be available for domestic staff, such as a nanny or a personal carer. There will also be some anti-avoidance provisions to prevent, for example, ‘doubling up’ relief by transferring the business to a new company.

The employer will make his claim as part of his usual PAYE Real Time Information (RTI) submission. He will be able to use HMRC’s Basic PAYE Tools to do this, and the formal claim will be by way of ticking a box on his EPS submission.

NIC exemption for under-21 year olds

In his Autumn Statement the Chancellor also announced that, from April 2015, no employer NI contributions will be payable on the earnings of under-21 year olds (unless, exceptionally, their earnings exceed the NI Upper Earnings Limit, estimated to be £813 a week for 2015/16). This new exemption means, for example, that if a 20-year old is paid £12,000 a year, his or her employer will save over £500 a year in employer NI contributions. If he or she is paid £16,000, the employer will save over £1,000. The employee’s entitlement to Social Security benefits will not be affected.

The new relief will not be time-limited and will be separate from, and additional to, the £2,000 a year ‘Employment Allowance’ described above.



Tax doesn’t have to be taxing!

If your tax affairs are simple and you want to complete your self assessment return but need a little extra guidance here’s where we can help.

Book now for a one-to-one two hour session with one of our qualified accountants for just £99. In this time we will:

Show you how to download free HMRC software onto your computer to complete your return;

Sit with you whilst you fill in your tax return online and answer any questions you have on the mechanics of completing a return;

Ensure you know how to send your completed return electronically through the Government Gateway and generate a confirmation receipt.

(Please note, this service assumes that you have prepared all the information needed to complete your return beforehand. We would be unable to complete workpapers to support your return on the day).

Owner managed businesses – dividend payments

Many people choose to incorporate rather than run their business as a sole trader-ship for tax reasons. So, how do you withdraw money from the company? And, what’s the best way to minimise your tax bill?

First off, you need to make sure you’re not going to be caught out by HM Revenue & Customs IR35 rules. These rules were introduced in 2000 to prevent individuals working through an intermediary (who would for all other intents and purposes be treated as an employee of the client), benefiting from reduced tax charges.
The legislation ensures that, if the relationship between the worker and the client would have been one of employment had it not been for an intermediary the worker pays broadly tax and NICs on a basis which is fair in relation to what an employee of the client would pay.
There is no set criteria used by HMRC to assess whether these rules apply in a specific circumstance. It’s all about the overall risk and control of a contract. To give you a feel, here is a list of questions you should ask yourself: Do you work under your own control or are you managed by the client? Are there occasions when clients don’t pay you and you have to write off debts? If you can not complete a job, does your contract permit you to substitute workers – i.e. do you employ staff? Do you provide your own equipment? ‘Yes’ answers to the above would imply you carried the risk and were in control of the contract. However, ‘yes’ answers to the following would indicate your contract was more like one between an employer and employee: Do you have a notice period? Do you have any employee benefits? Do you work for a single client (or have multiple clients)? Are you paid for a set number of hours regardless of work completed?
Remember, this is by no means an exhaustive list of questions. Hopefully it gives you a flavour, but we would always recommend you seek professional advice on the matter before going any further.
So, assuming you are not caught out by IR35 rules, the following explains how you could choose to extract money from your limited company and minimise your tax bill.
Step 1
Pay yourself a monthly salary through your company to utilise your tax free entitlement without you or the company incurring any income tax or National Insurance. This currently equates to £148 per week, although the amount is likely to increase in April 2014 when the Government’s new £2,000 employment allowance is introduced. (No-one knows exactly how this will work at the moment, but it is likely to bring the threshold for paying NIC’s into line with personal allowance of £10,000. This could mean, employees/employers will suffer no tax below £192 a week.
Step 2
Each month, transfer additional funds from the business to cover personal expenditure in the form of a director’s loan.
Step 3
Declare a dividend at the year-end to cover loan amounts withdrawn throughout the year. BUT NOTE:
 – Dividends can only be paid out of distributable reserves – i.e. cumulative profits made in current and previous years – so don’t withdraw more than you’re earning;
 – Dividends must be agreed at a board meeting (if there is more than one company director) and meeting minutes drawn up stating amount of dividend declared;
 – You must raise a dividend voucher for each shareholder entitled to receive the profits distributed stating dividend paid as net and the dividend tax credit. (See below for more info on dividend tax credits).
Dividend tax credits
This is a nominal credit which means that a basic rate tax payer is deemed to have ‘paid’ the tax arising on dividends received and a higher rate tax payer only has the incremental amount of tax to pay. Dividend tax credits will never give rise to a repayment of tax, however, as this is a purely notional credit unlike PAYE deductions.
So, how much tax will I pay?
The below example shows how much tax a company with gross profits of £55,000 employing one director could pay using the method outlined above. In this example no National Insurance is payable…
A company generates £60,000 from contracts undertaken during the year and incurs costs of £5,000 thereby generating a profit of £55,000 before payment of any salary to its sole employee – a Director.
Salary payments below the tax/ NI threshold of £7,600 are made during the year. This leaves the company with a net profit of £47,400 on which it must pay corporation tax at 20%.
Assuming there are no profits in the company brought forward from previous years, after a corporation tax charge of £9,480, the company is left with distributable reserves of £37,920 out of which it can make a dividend payment to its sole director and shareholder:
Company profits                                                                                         
Income                                           £60,000
Expenses                                       (£5,000)
Gross profit                                   £55,000
Director salary                                (£7,600)
Net profit                                       £47,400
Corporation tax (at 20%)                (£9,480)
Distributable reserves                  £37,920
The current basic rate threshold is £41,450, so after receiving a salary of £7,600 the director can receive a net dividend payment of £30,465 (after accounting for a dividend tax credit of £3,385)  without incurring any taxes. However, if he wishes to withdraw the maximum amount available, the remaining dividend payment of £7,455 will be taxed at an effective rate of 25%. This means there is an overall effective (cash) tax rate of 20.6% payable by company/ director on gross profits of £55,000.
Director’s drawings from company                   Tax credit          Tax to pay
Salary                                                £7,600
Dividend (at basic rate)                   £30,465                £3,385
Dividend (at higher rate)                   £7,455                   £828                 £1,864
Tax payable
Company’s corporation tax               £9,480
Director’s income tax                        £1,864

Effective (cash) tax rate                   20.6%

Everyone’s circumstances are obviously different, however, and professional advice should always be sought in order to consider all the wider ramifications of any particular business structure.

Tax tips – private lettings relief

Private lettings relief
If you rent out a property that was once your Principal Private Residence (PPR) you will be entitled to lettings relief when you sell it. This relief can be worth up to £40,000 against the gain on the disposal of the property. Note, the relief is per person so if the property is held jointly, relief of up to £80,000 can apply.

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It all comes out in the wash!

Tax free payments to employees to cover laundry and other cleaning expenses

It is often not appreciated that an employer can pay his employees tax free allowances for the cost of washing or dry cleaning clothes they are required to wear for work. However, this applies only where the clothes count either as ‘protective clothing’ or as ‘uniform’.

Protective clothing means items such as overalls, gloves, boots and helmets, which the employee has to wear in order to be able to work safely. However, HMRC does not accept that warm clothing for working in exceptionally cold conditions is ‘protective’, or that high visibility clothing necessarily qualifies.

A uniform can be either clothing that anyone would recognise as workwear for a particular job, such as a nurse’s uniform, or clothing on which the employer’s name or business logo is prominently displayed. In the latter case, it is not sufficient for the clothing to be in corporate colours, or for the employer’s name to appear on a clip-on badge, or on a label sewn inside a jacket etc. There must be a label sewn on the outside. Each item of clothing is considered separately – thus if a shop assistant is required to wear a matching jacket and skirt, but only the jacket displays the employer’s name, then only the jacket will count as ‘uniform’ for tax purposes. (And they say tax doesn’t have to be taxing…)

The tax rules for cleaning expenses are the same whether the employer provides the protective clothing or uniform, or whether the employee has to buy his own. The employer can either reimburse against receipts for amounts actually spent (for example, where clothes are dry cleaned) or pay a flat rate cleaning allowance of up to £60 a year (£5 a month), for example where overalls are washed at home.

If the employee earns less than £8,500 a year, such payments are simply not taxable. However, these days that will only apply to part-timers and some apprentices. Otherwise, strictly speaking the payments should be reported as reimbursed expenses on Forms P11D and the employees should claim corresponding deductions. In practice, it will be more convenient to agree a ‘dispensation’ with HMRC – shortly put, if HMRC are satisfied that the payments qualify to be made tax free under the above rules, it will agree that they need not be reported on Forms P11D.

In any case, payments made by the employer to reimburse the cost of cleaning qualifying protective clothing and uniforms are not subject to employer’s or employee’s National Insurance contributions.

Workwear provided by the employer. A related point is the tax position where an employer provides workwear for his employees, If this qualifies as ‘protective clothing’ or ‘a uniform’ under the above rules, the same tax and NIC treatment applies as for cleaning expenses – namely that the employer should include as a benefit-in-kind on the employee’s P11D, unless a dispensation is agreed, but no National Insurance contributions will be due. If the clothing is given to the employee, the reportable amount is the cost to the employer, but if the clothing remains the employer’s property, an amount equal to 20% of the cost should be reported each year the item is worn.

VAT registration

VAT is probably the most dangerous of all taxes for a small business, firstly because it is charged on turnover, not profit, so any mistakes can be expensive; secondly because most penalties are tax-geared; and thirdly because there are very tight deadlines for providing information to HMRC.

There are dangers both if you are not yet registered for VAT, and if you are:

If you are not already registered for VAT

The basic rule is deceptively simple – you must register as soon as your ‘taxable supplies’ exceed the registration threshold, currently £79,000 a year. The first point to watch is that ‘taxable supplies’ include the sales of goods and services that are VAT zero-rated, as well as those which are subject to VAT at the 20% standard rate or 5% lower rate. However, you do not have to count sales of capital assets used in your business. For example, a jobbing builder would have to total his charges to customers, but would not have to include the sale of his truck or cement mixer. broadly speaking then, unless you are making any VAT-exempt sales, your ‘taxable supplies’ for VAT registration purposes will be the same as your turnover for ordinary account purposes.

The second point is that the registration threshold is not necessarily £79,000 for your accounts year, it is £79,000 for the twelve months to the end of any calendar month. So it is essential to keep a month by month check on your cumulative taxable supplies for the last twelve months. It is of course entirely within the rules to limit your trading to avoid going over the registration threshold – a lot of small hairdressers close for an extra day a week for this reason.

Otherwise, the registration application should be submitted within 30 days of the end of the month in which the twelve-month rolling total of taxable supplies first exceeded £79,000. If it is not, a penalty will be charged, usually between 15% and 30% of the net VAT payable for the period from the date the business should have been registered, to the date it was in fact registered.

If there is a ‘spike’ in taxable supplies, so that they go over £79,000 for one twelve month period, but are likely to be less than £77,000 for the next, HMRC may (not necessarily will) agree that the business need not be registered. But you have to ask. If you take the chance and the VATman finds out, the business will be registered from the date it should have been registered until you in fact apply to deregister, with VAT payable on your sales, plus a penalty, for the whole of that period.

By the way, HMRC will not agree to allow a business to remain unregistered if the reason that taxable supplies in the coming year are likely to be less than £77,000 is that the proprietor intends to take an extended holiday.

If you are already registered for VAT

Obviously, you have to make your quarterly or monthly Returns on time, and pay the tax. All traders are well aware of that. Less obviously, a wide range of changes have to be notified within 30 days of their taking place. These include any change in the registered, legal or trading name of the business, its principal place of business, or its main business activity. If the business is carried on by a partnership, the admission of a new partner or the retirement of an existing partner must be notified, as must any changes in personal details, such as a partner’s private address or name (for example, if a woman changes her name on marriage).

However, it is fairly unlikely that HMRC will in practice charge a penalty for failing to notify any of the above changes, at least in the case of an innocent error or oversight which does not lead to any loss or late payment of tax. The real danger is that a change may take place which means that the existing registration should be cancelled and the business re-registered. The most common examples are where:

– a trader (or partnership) incorporates his (their) business, as a company or a Limited Liability Partnership (LLP).

– a sole trader takes on a partner (even where the new partner is, for example, his wife.

– all but one of the partners withdraw from a business, leaving that business to be carried on by the last remaining partner as a sole trader. For example, this could happen where a married couple carried on a business in partnership, one died, and the other continued the business as a sole trader.

Here, HMRC’s practice is to charge a penalty for failing to register the ‘post change’ business. Their starting point will be to charge a penalty equal to 15% to 30% of the net VAT payable for the period from the date the change took place to the date it was finally notified – even if that VAT was in fact paid, on time, under the existing registration for the ‘pre-change’ business. It is usually possible to negotiate that penalty down, but frankly it is a situation far better avoided by deregistering and re-registering within the 30 days allowed.