Profit extraction and investment for family and OMB businesses - Bodmin/Redruth

Profit extraction
and investment
for OMB and
Family
Businesses
7 December 2015

www.francisclark.co.uk
Chairman’s welcome
Brian Harvey
Partner

Housekeeping

What are we going to cover?
• Tax on business profits
• Tax relief on investment back into the business
• Tax on cash extraction
• Tax efficient investment
• Tax on indirect profit extraction / benefits in kind
• Tax on residential landlords

Scott Bentley
Partner

Business structure
Common Structures for a OMB Family Business;
• Sole Trade/Partnership
• Limited Liability Partnership (LLP)
• Limited Company

Tax principles for different structures
• Profits arising in a sole trader or partnership are added to the other
sources of income that the sole trader / partner has and tax is
charged at personal income tax rates
• Partners in an LLP are taxed as above.
• Companies are not subject to income tax but instead pay
corporation tax. Owner managers only pay additional tax if they
extract profits from the company.

Tax & National Insurance rates on profits
(working age owners)
Further Considerations;
• Corporation Tax Rate to be reduced to 19% in 2017/18, and to
reduce further to 18% in 2020/21 so the gap is going to get bigger!
Basic Rate Higher Rate Additional
Rate
Sole Trade/Partnership/LLP 29% 42% 47%
Company 20% 20% 20%

So what conclusions can we draw so far?
• If the business needs to retain profits then a company structure
offers a much lower tax environment meaning that more profit can
be retained.
• Why might we want to retain profits?
- To make debt repayments
- To make capital investments
- To expand the business and grow

Other options for the family business
• Bring family members into business as partners to share profits
• This can help to ensure that profits remain taxed at lower rates
without the need to move to a company structure
• Avoids complication of running a company
• If bringing them in as partners is inappropriate are all family
members paid properly? Could salaries be increased to ensure
better use of “family” tax bands?

But what if you can take all the cash out?
Comparison of tax rates between Sole Trade, Partnerships and
Companies where all profits made in a year are to be extracted;
Note This ignores the dividend allowance of £5,000 and sole trader /
partnership tax rates include NIC.
Basic Rate Higher Rate Additional Rate
2015/16 Sole Trader/Partnership 29% 42% 47%
Company 20% 40% 44.4%
Company 26% 46% 50.5%
Company 25.1% 45.3% 49.9%

Conclusions
• For higher and additional rate tax payers in service / professional
businesses companies look less attractive going forward if you look
purely at income tax savings.
• Still beneficial for basic rate payers but benefits eroded and is the
complexity worth it?

Investment in the business
• Profits invested back into the business may attract further tax relief
depending on what you do with them
• Pay down debt (capital not interest) – no tax relief
• Invest in land and buildings mostly no tax relief but could be some
via Capital Allowances on fixtures or other limited reliefs
• Buy plant , vehicles etc there is tax relief in the form of Capital
Allowances
• Undertake Research and Development and generous reliefs are
available.

Investment in the business on plant
and machinery
• Annual Investment Allowance (AIA) is an immediate 100% tax relief
for capital expenditure on qualifying plant and machinery used in the
business including fixtures in buildings.
• Currently the maximum amount of expenditure in a year that can
qualify for AIA in £500,000.
• From 1 January 2016 the maximum is reduced to £200,000.
• Expenditure in excess of these levels receives writing down
allowances at rate of 18%/8% on a reducing balance basis unless it
is in a separately favoured category such as Environmentally
Favoured Kit in which case 100% relief may still be due.
• For periods spanning 1 January 2016 the AIA transitional rules will
bite.

Practical steps
• Timing – bring expenditure forwards?
• If you cannot bring the expenditure forward you might improve your
position by changing your year end. But remember this is a timing
difference and there probably need to be other commercial reasons
for a change of year end
• Check that what you are buying does not get a 100% allowance
outside of the AIA limit (i.e. environmentally friendly kit)
• If the item concerned is likely to be sold within 8 years think about
“Short Life Asset Elections” this can accelerate allowances and will
be important going forwards

Capital Allowances in buildings
• Capital Allowances on ‘Fixtures’ in a Commercial
Property/Furnished Holiday Let .
• New rules for transactions post 1 April 2014 whereby need to fix the
value of “fixtures” between buyer and seller at date of disposal.
• Failure to do so may result in the building losing tax allowances
moving forwards.

Other land and property based reliefs
• Generally no tax relief for expenditure on land or on buildings (apart
from plant and fixtures therein as already mentioned)
• Business Premises Renovation Allowance (BPRA). Has potential to
give 100% tax relief for the renovation of unused business premises
in disadvantaged areas. Due to end in March 2017
• Land remediation relief, get 150% relief on clean up costs as long
as you didn’t do it! Exception Japanese Knotweed. But for
companies only.

Research and Development tax credits
• Companies only.
• For SME’s 230% tax relief for qualifying expenditure.
• SME- Turnover up to 100M Euros, 500 employees, assets 86 M
Euros
• If loss making can claim a repayable amount in the sum of 14.5% of
the enhanced R & D expenditure.
• Lots more industries coming in particularly food and drink.
• Key question is what is R & D?

So if you don’t need to invest how
do you get your hands on the cash?
• As previously outlined sole traders / partners already own profits so
there is no concept of “extraction”. They pay tax on profits whether
drawn personally or not.
• Conversely, profits belong to a company until they are extracted by
a shareholder. Common ways of extraction include;
o Salary
o Dividend
o Interest on loans
o Rental of assets used by the business but owned personally
o Pension contributions
o Benefits in kind (cars etc)

Increase in dividend tax!
Dividends were great!
But is that still the case?
The above are effective rates of tax on net cash drawn.
Old Rate New Tax Rate Increase in Tax
Basic Rate
Taxpayer
0% 7.5% 7.5%
Higher Rate
Taxpayer
25% 32.5% 7.5%
Additional Rate
Taxpayer
30.55% 38.1% 7.5%

Do we still love dividends?
• Dividends have generally always been more efficient that salary
• Why?- Because whilst you don’t get corporation tax relief on them,
they are not liable to National Insurance
• The lack of NI and the way that additional corporation tax and the
income tax on the dividend combined meant that you retained more
cash from a dividend than salary.
• With the extra tax on dividends is that still true?

Some examples
So lets consider a company has £100 of profit that it is happy to pay to
an employee / shareholder. It doesn’t care how it does it as long as the
cost to the company is only £100. How much cash will the recipient
retain under dividend or salary?
Basic Rate Higher Rate Additional Rate
Dividend
2015/16
£80 £60 £56
Dividend
2016/17
£74 £54 £50
Salary £60 £51 £47

However, good news for some!
• From 5th April 2016 a new £5,000 exemption from tax for dividend
income
• However, not a massive benefit to the owner manager where most
of the profits have historically been extracted by way of dividend
• For a higher rate tax payer the new tax exemption is outweighed by
the additional tax once dividend income exceeds approx £22K.
• Consider widening share ownership around the family to gain
multiple exemptions? Needs careful thought!

So do we still love dividends?
• Yes we do, just not quite as much!
• Some may make the decision that given the reduction in saving the
simplicity of a net wage has appeal
• Other benefits re mortgage applications etc
• Ongoing consultation by government into the taxation of company
distributions. So watch this space.
• Possibly different dividend rules for owner / managers
• May target income disguised as capital

New dividend tax
Opportunities
• Pay a large dividend now if the business has distributable reserves?
• Generally we like to delay tax liabilities but for some it may be worth
paying less tax sooner!
• Do not forget that whilst the company must have the reserves, this
does not have to be paid by the company in cash instantly and can
stand on a loan account and paid when cash flow allows.

Interest on loans
• If you lend money to your limited company you can charge interest
on it. Maybe an undrawn dividend!
• From April 2016 basic rate tax payers get first £1K of interest tax
exempt reduced to £500 for higher rate tax payers.
• Rate charged needs to be commercial but plenty of scope.
• Company will get corporation tax relief and recipient suffers income
tax
• Interest even above limit beats dividend (above £5k), so go here
first.

Rental of assets owned personally
• In reality probably talking about premises
• Business gets tax relief on rent
• Owner pays income tax
• Beats salary or dividends (above £5k)
• Same tax cost as interest
• However some significant capital taxes issues so think carefully.

Pensions
• Was a dirty word but not any more.
• Company can pay into a pension and generally get corporation tax
relief. No personal tax on individual at this point.
• Tax deductible for Company providing the expense is ‘wholly and
exclusively’ for the purposes of the trade.
• If aged 55 or over it can be possible to immediately access 25% of
the contribution “tax free” without any adverse consequences
• Other funds can then all be accessed at a later date but subject to
tax
• Think of the pension scheme as a tax efficient “parking space”

Alan Turner
Chairman/Francis Clark
Financial Planning

www.fcfp.co.uk Twitter.com/francisclarkifa
Agenda
• Pensions
o Profit Extraction
o Property SIPP
• Tax efficient investment – EIS & VCT
o Profit Extraction
o Business Sale
• Summary

Profit Extraction
Options
• Pay the tax and offset the liability somewhere else
• Don’t pay the tax

Pensions
Why bother?
• Always been tax efficient
• But previously restrictive;
o Inaccessible
o Compulsion to buy an annuity
o Punitive charges on death
• All change!

Profit Extraction - Example
Tax efficient investment
• Company Director receives income of £50,000pa
(higher rate tax payer)
• Additional Company profit of £50,000
• Aged over 55

Pensions
Withdraw £50,000 as dividend
• Pay corporation tax on profit; £10,000
• Pay £13,000 as income tax
Or…
Apply £50,000k as salary
• Pay £17,575 as income tax
• Pay total National Insurance of £6,940
Profit extraction
£27,000 net
£25,485 net

Pensions
Or….
• Pay pension contribution of £50,000
• No corporation tax, income tax or NI
On immediate withdrawal…
• £12,500 paid tax free
• £37,500 taxed; £22,500 net income
• But…… future contributions limited to £10,000
Profit extraction
£35,000 net

Property SIPP - Example
Pensions
• Aged over 55
• Has a SIPP in place (value £60k)
• But has not contributed for a few years
• Company owns a business premises

Pensions
Property SIPP
• Makes an in specie pension contribution of the
property – valued at £180,000 – to the SIPP
• Care possible corporate tax on the gain
• (some would say that’s a convenient figure)
• Director now has control over the premises and the
pension fund has a solid return from the rent
• Can withdraw 25% tax free
• £60,000 tax free
• (also convenient)

Pensions
Property SIPP
• And the remaining fund (£180,000) is tax free on
death, too!

Pension reforms – Death benefits

• I want to extract funds, not tuck more money away!
• Why would I bother?
• A means to offset tax liability
• With careful planning, cash-flow can be managed
Wait a minute…….

Tax Efficient Investment
Enterprise Investment Scheme (EIS)
Venture Capital Trusts (VCT)
• Designed to encourage investment in UK small
businesses
• Offer tax incentives – but must be held for minimum
period
• Can be ‘Evergreen’
• Recent demand has shown a need for capital
preservation and exit opportunity

Income Tax Relief
Minimum Term
Maximum Investment
Minimum Investment
Dividends
Growth
CGT Deferral
IHT Exemption (BPR)
Loss Relief
EIS
30% (plus carry back)
3 years
£1m (each)
c. £20,000
Taxed
Tax Exempt
Yes – no maximum
After 2 years
Yes
VCT
30%
5 years
£200,000
c. £5,000
Tax Exempt
Tax Exempt
No
No
No

Profit Extraction – Example 1

Profit Extraction
Company
Profits
£28,625 Net
£11,375 Additional
Tax Liability*
£40,625 Net
£12,000 Income
Tax Relief
£40,000
EIS or VCT
£40,000 Dividend
Paid
*Assumes that £5,000 dividend allowance can be
used by the dividend

Business Sale – Example 2
• Trading business started with nothing, then sold for
£500,000
• CGT of £50,000 (Entrepreneurs’ Relief)
• £30,000 of income tax paid annually
• Nil rate band (and residence nil rate band) used by
other assets

Business Sale
£500k + £36k + £325k +
£175k = £1,036,000 to heirs
£60,000 Income Tax Relief,
less £24k IHT
£500k; CGT deferred and
IHT free (replacement business
property relief)
£500,000
Other
assets
£500,000
Business
£270k + £325k + £175k =
£770,000 to heirs
Less £180,000 IHT
Less £50,000 CGT
Sold with no planning
Sold and reinvested in EIS

Summary
• You can withdraw company funds tax efficiently
• With a little planning, tax efficient investments can
offset tax liabilities
• And pensions have become the fulcrum of financial
planning – for profit extraction and more….

www.fcfp.co.uk
No responsibility can be accepted for any action taken as a result of information contained in this
presentation. We therefore strongly recommend that no action should be taken before obtaining
detailed professional advice.
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them may go down as well as up and an investor may not get back the amount invested.
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Staff entertaining
• Christmas party?! – Regular, Annual events open to all staff and
below £150 per head including VAT per annum are tax deductible
for the company and not taxable on the individual. Even if you are a
husband and wife company.
• Happy Christmas!

Childcare costs
• New system of childcare support from 1 April 2017
• Government to contribute 20p for every 80p paid into a newly
created Childcare Account. Max of £2K per child
• Both parents must work at least 16 hours per week on the living
wage current scheme does not require both parents to be working.
• New scheme applies to children under 12 current scheme applies to
children up to 15
• New scheme available to the self employed.
• Should you take advantage of current scheme?

Company vehicles
• An emotive subject!
• No income tax liability arises on an employee who is provided with a
van and takes it from home to work providing no other private use.
• If there is private use then a fixed rate tax charge applies
• No income tax charge arises on a car used 100% for business
purposes but difficult to support!
• Income tax charge arises on a car provided to employee where any
private use including home to work.

Company vans
Provision of a Van for employees
• Where private use, tax is based on a deemed charge – 2016/17
£3,170 assessed at the individuals marginal rate of tax.
• Fuel benefit – 2016/17 – £598 where private use of van and private
provision of fuel.
• Class 1A NIC (13.8%) payable by the company on the provision of
any benefit.
• Tax payable by a basic rate taxpayer in 2016/17 who is provided
with a van for private use and fuel - £754.

Company cars
The tax charge arising on the provision of a car is arrived at by
multiplying the list price of the car when new by a percentage
determined by its CO2 emissions. The appropriate percentage for cars
with CO2 emissions figures are as follows;
A diesel supplement of 3% is applied to diesel cars for each level of
CO2 emissions in the table above but so that that the maximum levels
of 37% and 35% are not exceeded.
CO2 – g/km 2014/15 2015/16 2016/17
0 0% 5% 7%
1-50 5% 5% 7%
51-75 5% 9% 11%
76-94 11% 13% 15%
Each 5g/km Add 1% Add 1% Add 1%
Maximum 35% 37% 37%

Some thoughts on cars
• What is a van? Double cabs ok providing capable of carrying
1000KG
• However Combi vans etc could be questionable.
• As cars get cleaner the percentages are going up for given C02
levels but the list price doesn’t change. So as your car is getting
older the tax cost is going up. Older cars in companies generally a
bad idea!
• Second cars in families can still make sense, need to look at the
numbers.
• Separate charges arise on provision of fuel based on a flat rate of
£22,200 from April 2016 multiplied by the relevant percentage.
Rarely worth the cost but pay for simplicity?

Residential landlords under attack
• Income tax relief on interest on borrowings used to finance
residential lettings is being restricted for individuals.
• Phased in over 4 years from 2017.
• Will restrict tax relief to basic rate
• For individual landlords with substantial borrowings tax increases
are significant.

Residential landlords under attack
• CGT to be payable within 30 days of property disposal from 2019.
• 3% additional SDLT for purchasers after April 2016.
• Many looking at incorporation but not straightforward and needs
significant thought.
• Availability of finance as a corporate structure will be an issue for
many.

Chairman’s closing remarks
Brian Harvey
Partner

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