Chris Thorpe explores some options available to owners who wish to extract profits out of their companies.
A company with a large amount of cash on the balance sheet is obviously a ‘good thing’ for the company’s owners. The only problem is how to get it out, and in a tax-efficient manner?
Is surplus cash a problem?
Before looking at that, it might be worth a quick reminder about why a large amount of cash on the balance sheet might be a problem. For capital gains tax (CGT) purposes, HMRC might regard the company as not being ‘substantially’ trading if the cash is deemed to be surplus to requirements of the business and represents more than 20% of the company’s value.
If this happens, HMRC may not deem the company to be ‘trading’ for the purposes of the various CGT reliefs. If the surplus cash reserves are more than 50% of the company’s value, there is an additional danger that HMRC may regard it as ‘wholly or mainly’ an investment company for inheritance tax business property relief (BPR) purposes.
So as well as allowing for the enjoyment of the fruits of one’s labours, extracting cash could also avoid potential tax issues upon the sale/gifting of company shares, or upon death.
The usual suspects
The most common ways of extracting profits are a relatively small salary and/or pension contributions with the rest as dividends. Paying a salary and pension to other family members as employees can help, as can dividends to other family shareholders (ensuring that the ‘settlements’ anti-avoidance legislation is not disturbed). If large dividends are being paid this would ordinarily lead to a fairly high income tax charge, albeit with no National Insurance contributions (NICs).
However, if the shareholder can manage without the cash for a further three years, the dividends could instead be invested into enterprise investment scheme (EIS) shares in another company, which would mitigate most of the tax thanks to the 30% income tax relief available upon investment (also qualifying for 100% BPR after two years). After three years, the EIS shares can be sold CGT-free, releasing the cash with much of the original income tax washed out.
Other extraction methods
Besides remuneration planning for extracting profit, if the company is utilising/occupying a personally-owned asset, rent could potentially be charged for its use; although this has wider implications for the owner (e.g. business asset disposal relief, previously known as entrepreneurs’ relief) is restricted and, in any event, only 50% BPR is available for off-balance sheet assets.
If the surplus cash is on the balance sheet because of a director’s loan, interest could be charged to the company, potentially as high as 10-15%. As well as another NICs-free source of income for the owner, this may also allow them to utilise their 0% savings rate and personal savings allowance.
Until 2016, one option to remove all the cash in a tax-efficient way was to formally liquidate the company and receive the proceeds as capital. However, since then the ’anti-phoenixing’ targeted anti-avoidance rule will deny capital treatment if the proceeds are reinvested into another business carrying on the same or similar trade within two years and with no commercial justification for doing so. Therefore, formal liquidation is now only really an option when the owner wishes to retire. But what does ‘same or similar’ trade mean? We don’t know because, unhelpfully, there is no HMRC clearance available to assist.
Practical tip
Ongoing and effective remuneration planning should ensure that cash reserves are kept to a sensible and necessary level to maintain a company’s trading status, as well as maintaining maximum tax efficiency for profit extraction. Use of the EIS may be useful way to offset income tax when extracting larger dividends in the long term, but investing in EIS is fairly risky, so that must be considered and further advice sought.
