Finding the balance between your personal tax liability and your businesses’ can be a challenge. Corporation Tax remains a flat 19% on the profit you make, but there are numerous allowances and reliefs to take advantage of. Current and proposed Income Tax rates are:
- 0% Personal Allowance, up to £11,850, increasing to £12,000 2019/20
- 20% Basic rate, up to £46,350, increasing to £50,000 2019/20
- 40% Higher rate, up to £150,000
- 45% Additional rate, above £150,000
When you run your own business, the golden rule for tax-efficient income is to only draw what you need. Why pay unnecessary Income Tax? Beyond this, there are a number of other opportunities you should be taking advantage of which can reduce your tax liabilities:
Spousal tax planning
If you have a long-term partner, whether you’re married or not, it’s likely they contribute to the business in some way. Whether it’s helping with paperwork or organising logistics, it’s entirely legitimate that their input justifies an income. The level of work and reward should be appropriate and justifiable, rather than solely as a method of exploiting the tax benefits.
If your partner is in a lower Income Tax bracket than you, this will could save significant money over time, whilst contributing to your household income. This would also reduce Corporation Tax, rather than retaining profit within the business.
You will need to take into account additional spouse / company secretary National Insurance contributions, so it may transpire that if they are also a shareholder, dividend payments are the most tax-efficient.
Maximise pension contributions
Pensions might not be top of your agenda, you might even consider the sale of your business as your ultimate retirement plan, but there are significant tax benefits for you and your business if you make pension contributions:
- If you trade as a limited company, employer contributions are treated as a business expense, reducing Corporation Tax. You also won’t pay National Insurance on them
- If you are a sole trader or partner, contributions will also attract tax relief
- Any personal pension contributions you make are free of Income Tax
If in invested well, your pension fund will then grow tax-efficiently. Significantly, from age 55 under the Pension Freedoms changes which came in to effect in 2015, you are able to withdraw and spend the entire pension as you see fit. 25% will typically be tax-free and you’ll pay Income Tax on the remainder, so it’s often wise to manage the level of income over time to minimise tax.
The Annual Allowance is the maximum you can tax-efficiently pay into a pension. It is set at the equivalent of your relevant UK earnings, up to a maximum of £40,000. Relevant earnings do not include dividend income, so be mindful you are not accidentally exceeding the limit, which would attract other tax penalties.
You can then utilise SIPP or SSAS benefits
Of the various pension schemes available, Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSAS) have specific benefits especially attractive for business owners.
- Property: SIPPs and SSAS both allow you to purchase commercial property with their value. As a business owner, this could be the premises you are operating out of. You are also often able to borrow up to 50% of the pension value from a bank to help fund the purchase.
Your pension would own the property and the business would rent it back. There are Corporation and Capital Gains Tax benefits of doing this, so if you would like to discuss it in detail please get in touch.
- Lending: A SSAS (an occupational pension, typically set up for the directors of the business) has an additional benefit; the ability to lend money to the business.
You can borrow up to 50% of the scheme’s net asset value, as long as it is secured on an asset owned by the business. This is especially helpful to aid cashflow or fund expansion.
- Investing: Finally, a SSAS is able to invest directly in shares of your business, up to a maximum of 5% of the value of the pension. If you are a director of more than one business a SSAS can invest in any number of them, as long as the total combined value is no more than 20% of the pension value.
Real-world planning opportunities
There are many circumstances beyond tax-efficiently drawing income that we can help you with. Naturally, it depends on your circumstances, but we recently helped two clients achieve three key milestones:
Alan and Sue are 60 and 58 years old respectively and are Directors of their Ltd company. Between them, they jointly own their main residence and a commercial property. They had:
- £140,000 in savings and investments
- £315,000 in a Self-Invested Personal Pension
- £191,000 in total mortgage debt, over both properties
They were drawing excessive dividends and are concerned about the level of Income Tax they have been paying. Ideally, they’d like to become debt free as soon as possible and understand exactly when they are able to retire.
First, we established the cost of living for their current lifestyle and projected that into retirement. Then, once we had identified their expenditure and surplus wealth:
- Repaid £45,000 of their personal wealth back into the company
- Made a company pension contribution of £45,000 to their SIPP
- Entered Flexi-Access Drawdown, taking a £90,000 Tax-Free Cash from the SIPP
- Paid off both commercial and residential mortgages with the Tax-Free Cash
The three key milestone results:
- £23,175 saved in tax (£14,625 Income Tax and £8,550 Corporation Tax)
- Alan and Sue are completely debt free
- They are able to retire sooner than anticipated
It’s evident there are many opportunities to mitigate personal and business-related tax with a little planning. If you’d like to discuss your individual circumstances to see how we may be able to help you, please get in touch with one of our Chartered financial planners.