Really really stupid question
Discussion
OK, someone at work came up with a daft completely naive idea, but in my exhausted mind state I couldn't come up with the explanation as to why his suggestion is nonsense.
Basically he was saying:
Suppose you are making a profit each year. You then pay coropration tax on it. You let this accumulate for a few years, after which you take it out as salary (let's not bother with dividends for this). You will have been paying corporation tax AND then PAYE when you take it out.
On the other hand if, every year, you take out as much salary as necesary to make no profit, then you will not pay any corporation tax.. you will of course still be paying PAYE, but you won't ever pay any CT.
It sounded to me like an incredibly elementary question but for the life of me I cannot explain why both systems would work out the same in the long run. I guess when you finally take the money out in option 1, you would make a large loss in that tax year, which you could then carry forward into future years and pay no corporation tax... so maybe it's the same in the long run, except that with option 1 you have to keep going a few extra years to offset the loss against the next few years' profits, whereas with option 2 you are effectively getting the "no corporation tax" benefit every year.
Is that right???
Basically he was saying:
Suppose you are making a profit each year. You then pay coropration tax on it. You let this accumulate for a few years, after which you take it out as salary (let's not bother with dividends for this). You will have been paying corporation tax AND then PAYE when you take it out.
On the other hand if, every year, you take out as much salary as necesary to make no profit, then you will not pay any corporation tax.. you will of course still be paying PAYE, but you won't ever pay any CT.
It sounded to me like an incredibly elementary question but for the life of me I cannot explain why both systems would work out the same in the long run. I guess when you finally take the money out in option 1, you would make a large loss in that tax year, which you could then carry forward into future years and pay no corporation tax... so maybe it's the same in the long run, except that with option 1 you have to keep going a few extra years to offset the loss against the next few years' profits, whereas with option 2 you are effectively getting the "no corporation tax" benefit every year.
Is that right???
What would be the point of delaying drawing money out of your company - especially if, like most people, you may not have the luxury of exercising that option? In other words, you need personal imcome from the company for your everyday living costs.
However, if you WERE in a position where you DIDN'T have to pay yourself a salary, leaving money in the company might be a better bet.
Don't forget that Corporation Tax bands and rates are quite different to the bands and rates applying to personal Income Tax - not to mention the onerous National Insurance charges on salaries.
A limited company would pay less Corporation Tax on £100,000 profit than an individual would be charged Income Tax and NI on a gross salary of £100,000.
The main downside of delaying withdrawing money from the company might be the fact that two tranches of £50,000 salary spread over two tax years would result in an overall lower tax/NI bill than one slary amount of £100,000 all being taxable in ONE tax year.
However, if you WERE in a position where you DIDN'T have to pay yourself a salary, leaving money in the company might be a better bet.
Don't forget that Corporation Tax bands and rates are quite different to the bands and rates applying to personal Income Tax - not to mention the onerous National Insurance charges on salaries.
A limited company would pay less Corporation Tax on £100,000 profit than an individual would be charged Income Tax and NI on a gross salary of £100,000.
The main downside of delaying withdrawing money from the company might be the fact that two tranches of £50,000 salary spread over two tax years would result in an overall lower tax/NI bill than one slary amount of £100,000 all being taxable in ONE tax year.
I always think it's unwise to leave large sums of cash (and indeed property) in a business. The reason being, if the company ever got into trouble then those assets are up for grabs by all and sundry. As such, I tend to ringfence cash and property by taking them out of the company. Sure you're going to pay tax on them, but you'd do that eventually anyway. The only real commercial reason for leaving cash in a company, to my mind, is if you're selling the company and the cash is being bought, Pound for Pound, by the buyer - then you can sometimes (depending on the level of cash) get taper relief on it, which means you'll only pay 10% Tax.
Well
We are already drawing sufficient salary, but are making a (reasonably small but growing) profit on top. So the question is what to do with it - I had been leaving it in the business in order to keep options open. Leaving it in the business means it can be used for
a) Reserves if things get really tight one year
b) Purchasing another business to help grow this one
c) Pension contributions
or
d) Extra salary down the road if things have been stable for a while
I had always assumed that - as with most tax / finance related matter - it makes very little difference (aside from cash flow) WHEN you do things. For example our account always says, near the end of the tax year, "If you're planning to buy anything large in the near future you might as well do it now" because (obviously) it reduces the CT hit in the current year, but of course if we left it til next year, it would reduce next year's CT so no overall difference.
And I'm sure the question of taking all the profit out must be the same. I can't believe that one way you end up paying more CT than the other way; things just don't normally work that way.
I guess even if I'm right (about the big loss you get when you finally do take it out) - it wouldn't be that nice to have paid CT for three years, then take out the accumulated profits, make a huge loss, and then have to caryr on for a few more years in order to benefit from the loss. Much nicer to have not paid the CT at all in the first place. I guess.
Yes, the taper relief thing is useful. Then again I was reading today how if one of your parents was born outside the UK, you can give up your UK tax residency (not sure about the terminology) whilst keeping your UK passport, living in the UK and managing a UK business - but avoid even the 10% tax when you sell. But that's a different game.
So what's the verdict? It makes no difference in the long run? I think it woul dmake a difference if you saved the cash for, say, 4 years - and then for some reason decide to wind the business up. You would then make a loss when paying yourself the accumulated extra salary - but since you're winding the business up, you won't get a chance to recover the CT already paid by utilising the loss. SO you'd have paid the CT for those 4 years but then wouldn't be able to get it back....
We are already drawing sufficient salary, but are making a (reasonably small but growing) profit on top. So the question is what to do with it - I had been leaving it in the business in order to keep options open. Leaving it in the business means it can be used for
a) Reserves if things get really tight one year
b) Purchasing another business to help grow this one
c) Pension contributions
or
d) Extra salary down the road if things have been stable for a while
I had always assumed that - as with most tax / finance related matter - it makes very little difference (aside from cash flow) WHEN you do things. For example our account always says, near the end of the tax year, "If you're planning to buy anything large in the near future you might as well do it now" because (obviously) it reduces the CT hit in the current year, but of course if we left it til next year, it would reduce next year's CT so no overall difference.
And I'm sure the question of taking all the profit out must be the same. I can't believe that one way you end up paying more CT than the other way; things just don't normally work that way.
I guess even if I'm right (about the big loss you get when you finally do take it out) - it wouldn't be that nice to have paid CT for three years, then take out the accumulated profits, make a huge loss, and then have to caryr on for a few more years in order to benefit from the loss. Much nicer to have not paid the CT at all in the first place. I guess.
Yes, the taper relief thing is useful. Then again I was reading today how if one of your parents was born outside the UK, you can give up your UK tax residency (not sure about the terminology) whilst keeping your UK passport, living in the UK and managing a UK business - but avoid even the 10% tax when you sell. But that's a different game.
So what's the verdict? It makes no difference in the long run? I think it woul dmake a difference if you saved the cash for, say, 4 years - and then for some reason decide to wind the business up. You would then make a loss when paying yourself the accumulated extra salary - but since you're winding the business up, you won't get a chance to recover the CT already paid by utilising the loss. SO you'd have paid the CT for those 4 years but then wouldn't be able to get it back....
You can carry terminal loses back so you can recover CT paid previously.
Taking large sums of money personally in one year guarantees you will pay a large amount of personal income tax in the year you draw the money.
Spreading it out over a number of years reduces the overall personal tax burden.
Obviously, payment strategfy may need to change year on year to optimise situations caused by tax law changes - which, with Gordon Brown at the helm, is almost EVERY year.
Taking large sums of money personally in one year guarantees you will pay a large amount of personal income tax in the year you draw the money.
Spreading it out over a number of years reduces the overall personal tax burden.
Obviously, payment strategfy may need to change year on year to optimise situations caused by tax law changes - which, with Gordon Brown at the helm, is almost EVERY year.
a chap said:
You can carry terminal loses back so you can recover CT paid previously.
Ah, OK, didn't know that.
And yes, a concern is definitely the constant changing of rules. Suppose he changes his mind on taper relief??
Anyway.. by the time we've factored in bonuses, hardware / software upgrades and salary increases, there will be sod all left anyway :-(
There used to be a Capital Gains Tax relief known as Retirement Relief but that was abolished a number of years ago. Retirement Relief was only available on the disposable of a "Trading" business (not all businesses actively trade or carry on trading avtivitires" and the recipent of the relief had to meet a number of "involvement" criteria.
Obviously, sale or disposal of a business is looked on as a Capital disposal and will be charged to Capital Gains Tax (rather than simple Income Tax and NI). Therefore, some of the additioanl reliefs applicable to CGT would kick in (Business Taper Relief, the personal CGT Allowance etc).
Winding up your companies every time you wanted to extract cash from it would not be very pricticable and might upset your customers, suplliers and the tax man.
Obviously, sale or disposal of a business is looked on as a Capital disposal and will be charged to Capital Gains Tax (rather than simple Income Tax and NI). Therefore, some of the additioanl reliefs applicable to CGT would kick in (Business Taper Relief, the personal CGT Allowance etc).
Winding up your companies every time you wanted to extract cash from it would not be very pricticable and might upset your customers, suplliers and the tax man.
Edited by Eric Mc on Thursday 7th December 08:05
zadumbreion said:
Suppose you are making a profit each year. You then pay coropration tax on it. You let this accumulate for a few years, after which you take it out as salary (let's not bother with dividends for this). You will have been paying corporation tax AND then PAYE when you take it out.
You probably realise this, but it's not clear from what you've written - you only pay CT once on each years profit. ie if you keep it in the company, you don't pay CT on it again next year.
"You" have not paid Corporation Tax, the company has.
"You" pay PAYE Income Tax and Class 1 NI on the salary amount - and the company pays Employer's NI on the salary too.
In the year the salary is drawn, the company can offset the gross salary PLUS the Employer's NI agianst its profits, thereby reducing its Corporation tax liability in that year.
"You" pay PAYE Income Tax and Class 1 NI on the salary amount - and the company pays Employer's NI on the salary too.
In the year the salary is drawn, the company can offset the gross salary PLUS the Employer's NI agianst its profits, thereby reducing its Corporation tax liability in that year.
Eric Mc said:
"You" have not paid Corporation Tax, the company has.
"You" pay PAYE Income Tax and Class 1 NI on the salary amount - and the company pays Employer's NI on the salary too.
In the year the salary is drawn, the company can offset the gross salary PLUS the Employer's NI agianst its profits, thereby reducing its Corporation tax liability in that year.
"You" pay PAYE Income Tax and Class 1 NI on the salary amount - and the company pays Employer's NI on the salary too.
In the year the salary is drawn, the company can offset the gross salary PLUS the Employer's NI agianst its profits, thereby reducing its Corporation tax liability in that year.
spot in... if there are no profits that year then the loss incurred by drawing a salary can be carried forward until it can be offset against a suffient profit.
salary and related costs are taxable allowances
Apparently there is still some sort of concession whereby your final withdrawal of profit can be treated as a capital gain, not too sure of the details.
But back to the original question - since you can only claw back CT one year in the past, in the artificial scenario described (where dividends are not an option) then it may make sense to take the salary each year and eliminate CT. However since dividends ARE an option for me in real life, the best approach would seem to be what we are currently doing: pay CT and then take anything left out as dividends. This can be done yearly or in one go later without affecting anything so it's flexible as well as tax efficient.
But back to the original question - since you can only claw back CT one year in the past, in the artificial scenario described (where dividends are not an option) then it may make sense to take the salary each year and eliminate CT. However since dividends ARE an option for me in real life, the best approach would seem to be what we are currently doing: pay CT and then take anything left out as dividends. This can be done yearly or in one go later without affecting anything so it's flexible as well as tax efficient.
And that is the reason Dividends are such a popular technique for removing personal income from a company. So lomg as the company can afford to pay them and all the various pitfalls are avoiuded, then Dividends are still, in most cases, thhe most tax efficient way of deawing income out of a company.
if i am not mistaken, dividends arent tax allowable, that means CT is payed prior to divis being.
divis are then subject to tax at 10% or 33% dependant on personal circumstances.
the only saving would be NI (ER's and EE's)
The best solution would be a combination of salary and divi's were you maximise the bands for both. ie keeping salary in the 22% tax rate and divi's in the 10% rate...
divis are then subject to tax at 10% or 33% dependant on personal circumstances.
the only saving would be NI (ER's and EE's)
The best solution would be a combination of salary and divi's were you maximise the bands for both. ie keeping salary in the 22% tax rate and divi's in the 10% rate...
The 10% tax on dividends is notional and is NEVER actually paid. All it does is serve to increase the value of the dividend in the hands of the recipient and accelerate his/her earnings towards the 40% tax bracket a bit more rapidly. Once the 40% tax bracket is broached, the element of the dividend which falls into the 40% bracket is actually taxed at 32.5%.
Stephanie Plum said:
Isn't there a legitimate tax fiddle whereby you can liquidate a company after two years and extract the cash paying only corporation tax? This is assuming of course that the company has no debts at the point of liquidation?
Isn't that to do with AIM listed companies and donations of stock to charity? Or is that something completely different?
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