What's in this guide?
- What's the most tax-efficient way to legitimately take money from your business?
- What are the key things to consider as an owner-director regarding director's loans?
- Best practice for non-business expenses
- Best practice for bank accounts
Covid-19 update – ‘startups relief’
On 20 April 2020, the government published details of a £1.25 billion support package for innovative early-stage businesses struggling through the Covid-19 outbreak.
Support is being offered via a £500 million investment fund (The Future Fund) and a further £750 million of support for SMEs focusing on research and development (R&D).
The Future Fund will be administered by the British Business Bank and goes live for applications on the 20th May until the end of September 2020. It will provide convertible loans from the government and private investors worth between £125,000 and £5 million in return for an equity stake in the company. To be eligible, a company must already have raised £250,000 in equity funding.
Funding for R&D is to be managed by Innovate UK who it is also intended will begin making grant and loan payments to eligible businesses from mid-May also.
Both support arrangements leave a lot of questions, and some substantial concerns outstanding. The government is expected to issue more updates and details addressing issues raised on them both, in the coming weeks, ahead of their go-live dates.
Bounce Back Loans
From Monday 4th May, there will be a new fast-tracked loan scheme for small businesses. The scheme aims to provide businesses with much-needed finance within days, with loans backed by a 100% guarantee from the government for sums between £2k–50k.
Visit the government's website here for more information.
If you run your small business using a limited company model, there are a number of ways that you can legitimately extract funds from your business in a tax-efficient manner.
‘Legitimately’ is a key word here, because the profits and assets of a limited company belong to the company, not the business owner or directors. Unlike sole traders, whose personal and business assets are indistinct, and who can therefore allocate their income as they choose, limited company owners must comply with the UK’s company law when taking money out of their businesses.
The guide below explores the four most common and efficient ways in which they can do so. Critically, for a number of these options, the company needs to be in profit for the directors to be able to take money out, (which includes having settled all tax and other financial liabilities first), and any arrangements must be properly recorded and accounted for.
Taking money out of a limited company is otherwise likely to be problematic and might even constitute fraud and a breach of the directors’ legal obligations under UK law.
We asked Aaron Patrick, one of our favourite Farillio experts and head of accounting at Boffix, to summarise best practice in relation to these three legitimate ways to extract money from your limited company.
At the end of the guide, Aaron also covers a few key areas where you might be able to get more money into your business too. Farillio has more detailed guides on each of the areas that he mentions.
Aaron also delves into the topic of how to pay yourself as a business owner in much more detail in his video guide on this topic.
1. Director's salary
Even if you’re a sole director, you can become an employee of the business and pay yourself a wage. To do this, you must ensure the company sets up a payroll scheme. It is common practice for sole directors to pay themselves a small salary of around £8,500 per annum (depending on the given tax year), which is commonly referred to as ‘the director's salary’.
Neither the sole director nor the company will pay National Insurance contributions in these circumstances; however, the above level of salary ensures that this salary counts towards state pension contributions.
It may also be possible to employ other family members and use all available personal allowances.
For example, if you have family members who are not employed and so they’re not claiming their tax free allowance, you could look at employing them for a few business-relevant duties and including them on the payroll.
The advantage here is that their salary is a taxable deductible expense for your company (i.e. you can take the expense off your revenue before it’s made subject to tax calculations), while the individual would have no tax payment liability as long as their salary remained at the level of/below the allowances.
Wages paid to family members must represent a fair market value for the work performed, however. To show fair market value, you need to be able to prove that you would pay a non-related member of staff the same hourly rate/salary for the same business-relevant tasks, (and don’t forget about the national minimum wage). And you’ll need to have some form of credible paperwork to record that you made this assessment and reached a reasonable conclusion.
If you’re running a family business, check out our family business guides and materials designed to support you with decisions on ownership, management and financial decisions.
Providing the company has enough cash reserves, directors can authorise the payment of a dividend to the owners (shareholders) of the company.
A ‘dividend’ is essentially a tranche of money that can be paid to company owners, typically in proportion to their shareholding stake in the company. For example, put simply, a shareholder owning 20% of the ordinary shares of a limited company might normally expect to be entitled to 20% of the dividend pot available.
- the company must have made a profit after all tax and other financial liabilities have been paid (called ‘distributable profit’)
- the amount of overall dividend allocation cannot exceed the profits that the company has generated (otherwise this will be treated as a loan and must be treated and accounted for quite differently, with very different consequences (including tax treatment) for the individual recipient)
- if you want to pay a dividend to one or more shareholders, you generally should pay a dividend to all shareholders unless you have a class of shareholders you've not allocated this entitlement to
A good rule of thumb is to set aside a cash reserve of revenue each month. How much you set aside will often depend on your business sector and type of business, as well as the prevailing economic climate and how well you expect your business to perform.
You may find that 10–15% is a decent amount; an accountant will be able to help you gauge a sensible amount for your particular circumstances. And then, at the end of your financial year, once all other liabilities have been accounted for, you should have a decent sum to allocate to dividends and any bonuses, etc.
How much tax do individuals pay on a dividend they receive?
Every individual has a tax-free dividend allowance. Check here for the latest £ threshold. For 20/21 it's £2000.
Any dividends above this limit are taxed at the following rates depending on what tax band the income falls within. So, for 20/21:
- Up to Basic Rate (currently £12,501 – £50,000 for 20/21): 7.5%
- Higher Rate (currently £50,001 – £150,000 for 20/21): 32.5%
- Additional Rate (currently over £150,000 for 20/21): 38.1%
Always check that you have the latest threshold figures.
If family members also own shares in the limited company, they can also take advantage of their own tax-free dividend allowance before they would also be liable to pay tax on monies received over the allowance threshold.
Make sure you take tax and legal advice on any share issues, especially issues of shares to family members.
3. Pension contributions
The limited company can also pay contributions towards employee pensions. In fact, if the company has more than one employee, it is legally obliged to contribute to a pension for that employee (unless the employee voluntarily chooses to opt out).
These pension contributions are a tax-deductible expense for the business so long as the pension contributions are reasonable (proportionate) given the work performed by the employee.
So if you’re meeting those requirements, you can subtract the cost of paying in to the employee’s pension from your revenue, before it’s made subject to tax – meaning a lower tax liability.
Boffix advises that you always take good pensions advice before setting up or altering pensions arrangements.
Farillio’s experts, Redbourne Wealth Management are well placed to give this kind of advice. You can get to know them in their Pensions 101 guides, for employers starting out and for owner-directors of limited companies.
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