Many companies are struggling to find the capital that they need to grow their businesses – or even to pay the bills and maintain a healthy cash flow. Despite Government initiatives to encourage lending, banks seem reluctant to invest – and other sources of capital to fund growth can be hard to come by. However, at the same time, the Small Business Tax Action Report estimates that UK companies will pay around £7 billion more in taxes than they need to during 2012.
This is money that could be legitimately used to improve business in numerous ways; from hiring extra staff to investing in new technology. In my experience as the managing partner of a commercial accountancy practice which advises businesses in a range of sectors, there are five common areas that businesses should address to minimise their tax liability.
1. Set up a tax efficient structure
The way that a company is set up has significant tax implications. Depending on future plans for the company, the stage of the business and the risk environment that it operates in, a corporate structure may be the most tax efficient system. However, those who are self-employed should consider operating through a limited company structure which will minimise the impact of the 50% income tax rate.
The effective marginal rate for personal profits exceeding the higher rate threshold in the 2011/12 tax year is 42% (40% income tax plus 2% National Insurance contributions). This increases to 52% if exceeding the additional higher rate threshold. Whilst the mainstream Corporation Tax rate is now 24%, the small profit rate remains fixed at 20%. (The small profit rate relates to taxable profits not exceeding £300,000 and the mainstream Corporation Tax rate for profits in excess of £1.5m.)
2. Salary or dividend?
Whilst the amount that a business owner pays themselves may remain the same, the tax payable will vary according to the method of payment used. The most common way is either by salary or dividend – with many choosing a combination of both. However, this involves two different levels of taxation.
- A salary payment (including employer’s NI), is an allowable deduction in arriving at the company’s taxable profit – and hence reduces the Corporation Tax payable.
- A dividend is not allowable for Corporation Tax purposes and is treated as a distribution of profits after taxation.
Drawing a dividend as opposed to a salary does have significant advantages, including the fact that each shareholder receives a personal saving. This is because no employee NI is payable; therefore more is kept by the taxpayer for every £1 drawn as a dividend. Payment by dividend can also improve cash flow compared to salary payment which is through PAYE, requiring a monthly cash outflow of tax and NI contributions. Corporation Tax on the other hand, is only payable nine months after the year end, with the taxpayer paying the liability on the dividend on 31st January – after the end of the tax year in which the dividend is paid.
Payment by dividend needs to be carefully planned in advance as this form of profit extraction must be paid to all shareholders of the same class of shares. For legal purposes, they should be paid out as a distribution of profits. Furthermore, if deciding not to take a salary, you will forfeit certain benefits such as access to a pension fund and entitlement to the benefits of a sickness insurance scheme.
3. Claiming R&D
Since the April 2012 Budget, the amount of tax deduction for companies involved in research and product development (R&D) has significantly increased. A company can now receive up to 225% relief against Corporation Tax if their work during the past (including the last two tax years), present or future qualifies. Research suggests that this is an area that many organisations fail to investigate; often because they erroneously believe that they won’t qualify. The application process is quite complex so it is worth consulting a professional if considering making a claim.
4. Enterprise Management Incentive Scheme (EMI)
The EMI is a share option that allows for special tax treatment, allowing £120,000 of options to be granted to an employee with no income tax charge. However, not all employees are eligible and performance conditions can be added to employees’ shares that must be met.
5. Tax shelters
Despite recent negative media publicity, tax shelters are a perfectly legitimate way of deferring tax liability. There are three shelters that a company or individual can take advantage of.
- Pension schemes: a tax free zone for assets to grow in value. A company pension scheme is also an allowable deduction when arriving at taxable profits.
- Enterprise Investment Scheme: offers generous Income Tax and Capital Gains Tax relief to investors in certain types of companies. It enables any CGT chargeable to be deferred indefinitely, if reinvested into a new trading company. The investment must be held for at least three years, whilst business property relief is available for Inheritance Tax purposes after two years.
- Venture Capital Trust: essentially a company which is set up as a vehicle to invest in various risky new businesses. Individuals can buy shares in the VCT.
Tax is a necessary part of a civilised society; however, there are no prizes for paying more than you should. As one of an organisation’s major expenses, it’s important to ensure that you meet your liability, but that you retain the maximum amount legally available to you for growth and investment.
