Alan Pink looks at some potential ways of taking money from a company without incurring income tax or capital gains tax.
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It has often been commented that the tax benefits of running a business through a company can be more apparent than real.
The main benefit, of course, is the fact that companies pay tax at a lower rate (generally speaking) than an individual would pay on the same profits if that individual was trading as a sole trader or as part of a partnership. But this benefit is more apparent than real when the individuals behind the company (the shareholders and directors) then decide to extract money from the company. This extraction is most likely to be by way of dividends, which, although generally more advantageous than remuneration (because of the lack of National Insurance contributions (NICs)), comes with a penalty in the form of what has been called the dividend tax; an additional levy of broadly 7.5%, which has applied to dividends in recent years.
You can end up with pretty much the same amount paid to the government, even going down this road, as would have been the case if you had received the profits directly as an individual, even allowing for self-employed NICs.
Tax-free profit extraction
So, it becomes quite interesting (to put it mildly) to consider ways of taking money out, not just tax-efficiently, but even tax-free.
What follows is a selection of some of the most effective tax-free profit extraction techniques I’ve seen in practice.
Share capital reductions
Most companies these days come with a nominal amount of share capital only, perhaps only £1 or £100. But some companies may have issued share capital of a much more substantial amount. For example, a public company needs to have a minimum share capital of £50,000 (although I understand that some have found loopholes in this requirement, enabling a PLC to have a lower share capital).
However, if you find that you do not need to be a PLC, or if you have a private company with an other than trivial amount of share capital, repaying some of the company’s shares at par is not just much easier these days than it used to be (following changes to company law), but it can also be a way of taking money out of the company without income tax, in the same way as repayment of loans previously made to the company.
That’s entertainment!
Business entertaining can provide (perhaps unexpectedly) a mechanism for extracting value from the company without a personal tax charge. It’s well known that entertaining expenditure isn’t an allowable deduction against the company’s profits for tax purposes. And it’s also the case that, if you and your spouse simply go out for a slap-up meal and you pay for that meal with your company credit card, the amount that the company has spent on entertaining you constitutes a taxable benefit-in-kind, which needs to be disclosed on form P11D and NICs duly accounted for on it, in addition to the income tax bill.
But whether as a matter of informal practice or as part of a deliberate policy by HMRC, where the main purpose of the business entertaining is to promote the company’s business, and the entertaining is genuinely of a useful contact, supplier or customer, the fact that you as the company directors are entertained and perhaps have a very nice time is not counted against you in tax terms. So, although this is value taken from the company, in a sense for your personal benefit, and although the whole practice of entertaining is frowned on by our tax system, this is effectively equivalent to a dividend-in-kind, which is not charged to tax.
Provision for a brighter future
Pension contributions to approved schemes are a well-known way of taking value out of the company tax-free.
Of course, not everyone is a big fan of approved pension schemes. But there are situations (for example) when the individual is nearing or has passed retirement age when money can go into a pension scheme without a tax charge on the individual, but with tax relief in the company, and can then be paid out to the individual as a tax-free lump sum using the facility to pay 25% of the funds over in this way. It can simply be a case of using a little lateral thinking.
Selling assets to the company
If you don’t have a director’s loan account credit balance that you can draw on tax-free, why not look at seeing whether you can create some such credit? This can be done by transferring an asset into the company.
Not all such transfers are tax-free, of course. If you transfer an investment or a property which is worth more than it cost you, a capital gain will arise, and you can end up paying tax at rates of up to 28%. This might still be very much better than paying the rate of income tax that you would have paid on a dividend from the company; however, this article is about tax-free property extraction and not just tax-efficient profit extraction, so I’ll restrict myself to pointing out that not all assets that you can transfer to a company come with this CGT disadvantage.
For example, cars are not subject to CGT. Nor are loans owed to you by others.
Example 1: Tax-free withdrawals
Many years ago, Valerie lent £20,000 of her personal money to her friend Horace. Horace has not repaid the amount, but Valerie is confident that he has the funds to do so and, eventually, will write her out a cheque for £20,000 when his personal pension fund matures.
By way of formal assignment, Valerie transfers the benefit of this debtor balance to the company, in return for £20,000 credit to her director’s loan account with the company. This can then be drawn down by her out of company funds tax-free.
‘Parallel investment’ LLPs
A parallel investment limited liability partnership (LLP) can provide a way of investing post-corporation tax profits from the trade of the company in an entirely separate asset and environment – but without losing a proportion of this in income tax.
Example 2: Buying property through an LLP
Louise has spotted an ideal property to invest in, being what seems to her a significantly undervalued terraced property with a sitting tenant. The money to buy it is there, but the drawback is it’s in her company, Greece Guns International Ltd. If she takes the money out of the company as a dividend, the income tax will be 38.1% because she would be in the top rate applicable to dividends, in view of the amount involved and her other income.
Instead of taking the money as a dividend, she therefore takes it as capital introduced by the company into an LLP in which she and the company are members (partners). The property bought by the LLP in many ways is equivalent to a personally-owned property, including the ability to take capital gains, but no tax charge is triggered by the extraction.
Parallel investment LLPs can also be a useful way of extracting funds from the company tax-free when the individual just wants to spend it on personal living costs or improving or buying their own home. If the individual already has assets (e.g., investment properties) in their own name, the introduction of these assets into an LLP can produce a credit balance in the individual’s favour in the books of the LLP. This can then be drawn down, tax-free, out of cash introduced by the company as equity investor in the LLP.
Of course, there’s a lot more to it than that, but this is a practical tax-free method of extracting value from a company, which has been used many times by individuals in the real world.
