Sarah Bradford explores how profits can be extracted from a property company for personal use in a tax-efficient manner.
Changes in the ways that unincorporated landlords receive relief for interest costs in relation to residential lettings have led to an increase in corporate landlords. There are some tax advantages: interest and finance costs incurred in relation to residential lets are deductible in full in computing the property company’s profits for corporation tax purposes; and the highest rate of corporation tax at 25% is significantly lower than the highest rate of income tax at 45%.
However, the property company is a separate entity from the director-shareholders, and should they wish to use the rental profits for their personal use, they must first extract them from the company.
There are various ways in which this can be done; some more tax-efficient than others. This article looks at some of the options.
Salary or bonus
The starting point in formulating a profit extraction strategy is to consider paying a regular salary to meet regular personal expenses. If the director’s personal allowance is available, paying salary equal to the available personal allowance can be a tax-efficient option. For 2023/24, the standard personal allowance is £12,570.
Paying a salary at least equal to the lower earnings limit for National Insurance contributions (NICs) purposes (£6,396 for 2023/24) will ensure that the director secures a qualifying year for state pension and contributory benefits purposes. This is certainly worthwhile if the director does not yet have the 35 qualifying years needed to secure a full state pension.
Where the salary level is between the lower earnings limit of £6,396 and the primary threshold (£12,570 for 2023/24), primary NICs are charged at a notional zero rate. Paying a salary in this zone allows the director to benefit from a qualifying year for zero contribution cost.
As the personal allowance and the primary threshold are aligned at £12,570, if the director has not used his or her personal allowance elsewhere, a salary of £12,570 can be paid free of both tax and employee’s NICs. However, as the secondary threshold at £9,100 is below this level, if the National Insurance employment allowance is not available, as is the case in a personal company where the sole employee is also a director, there will be some employer’s NICs for the company to pay. This is charged at 13.8% to the extent that the salary exceeds £9,100, equating to a bill of £478.86 on a salary of £12,570. As both salary payments and the associated NICs are deductible in calculating the company’s corporation tax liability, this is a cost worth paying as the corporation tax saving of between 19% and 25% (depending on the level of the company’s profits) outweighs the employer’s NICs ‘hit’.
In a family company situation where there are two or more employees and the employment allowance is available, it will be possible to pay a salary of £12,570 free of tax and employee’s and employer’s NICs.
Once the salary exceeds £12,570, the excess will be taxed at 20% to the extent that it falls in the director’s basic rate band. The director will also have to pay employee’s NICs at 10%. Once this point is reached, other profit extraction routes should be considered.
Bonus is treated in the same way for tax and NICs purposes, and instead of paying a regular salary, the director could instead be paid an annual bonus of £12,570.
Dividends to shareholders
Dividends are a distribution of profit. Unlike salary or bonus payments, dividends are not deductible in arriving at the company’s rental profits; rather, they are paid from post-tax profits. Consequently, the profits from which dividends are paid have already suffered corporation tax at between 19% and 25%, depending on the company’s profits level.
Dividends can only be paid from retained profits and must be properly declared in accordance with company law requirements. In addition, where a class of share has more than one shareholder, they must be paid in proportion to the shareholdings; they cannot be tailored to the individual shareholder’s personal circumstances. However, this restriction can be overcome by having an alphabet share structure under which each shareholder has their own class of share.
Where dividends are paid, there may be further tax to be paid by the shareholder. All individuals have a dividend allowance, which for 2023/24 is set at £1,000 regardless of the rate at which the shareholder pays tax. Dividends that are sheltered by the allowance are taxed at a zero rate, but use up part of the tax band in which they fall.
If dividends received in the tax year (including any from investments in shares) exceed the dividend allowance and any unused personal allowance, there will be some tax to pay. Dividends are taxed at the dividend tax rates, which are lower than the normal income tax rates. They are treated as the top slice of income and taxed at the dividend ordinary rate of 8.75% where they fall within the basic-rate band, at the dividend upper rate of 33.75% where they fall in the higher-rate band and at the dividend additional rate of 39.35% where they fall within the additional-rate band.
If the property company is a family company, family members can be made shareholders. This provides the opportunity to extract further profits in a tax-free fashion, paying them dividends so that they can utilise their dividend allowance where it would otherwise be wasted. Here an alphabet share structure is useful to provide the flexibility to pay a different dividend to each family member.
It should be noted that the dividend allowance is set to fall to £500 for 2024/25, reducing the ability to extract dividends free of further tax.
Unlike salary or bonus payments, there is no NICs to pay on dividends, increasing their attractiveness.
Other extraction routes
Although taking a small salary and any further profits as dividends is a popular and tax-efficient profit extraction strategy, it is not the only route available for taking profits out of a property company for personal use.
If the business is run from home, rather than taking a salary, the company could pay the director rent for use of the home office. Unlike payments of salary, there is no NICs to pay on rent. However, the company still benefits from a deduction in calculating its taxable profits. Where the director already has the 35 qualifying years needed to secure a full state pension, this is an option worth considering. It is also a viable option if a salary up to the level of the personal allowance has already been paid and the director requires more funds for personal use, but the company lacks the retained profits to pay a dividend. Paying rent for a home office is also worthwhile if the director has rental losses from an unincorporated property business, which can be set against the rent.
The company can also make use of the various tax and NICs exemptions for benefits-in-kind to extract profits tax-free. Options here include providing the director with a mobile phone or providing trivial benefits costing no more than £50 each, subject to an annual cap of £300 for directors of close companies.
If profits are not required for immediate personal use, provision can be made for the future by making payments into the director’s personal pension. Although employer payments are limited by the available annual allowance, they are not subject to the earnings cap, which can be a benefit where the director’s only earnings are a small salary. Pension payments made by the company into a registered pension scheme are generally deductible in computing the company’s taxable profit, so they have the added advantage of reducing the company’s corporation tax bill.
Practical tip
Do the sums. People’s circumstances differ and there is no one-size-fits-all. Before withdrawing profits from your property company for personal use, it is important to consider how much you need to take out and how best to do this.
