Accumulating profits in your company (i.e. not triggering a personal tax charge) is basic tax planning and as long as you do not need to extract these surplus funds to live on, this can be considered to be a long term strategy as there are tax efficient ways to extract the money when your company ceases to trade.
In the short term, whilst you are accumulating these funds, there are a number of options that you can choose to make use of with regards to minimising the effects of the dividend tax reform, and these are set below:
If you expect to hold a significant profit in your limited company this year then it may be wise to draw out a large dividend before the changes come in to play on 6 April 2016, to minimise the tax charge on dividends in the 2016/17 tax year. It is important to consider your position before 5th April as you cannot backdate a dividend, so you can’t wait until after your company has had its financial year and go back and decide what you are going to call your dividends at a later date. You must also be careful before doing this to ensure that you do not cross into a higher rate tax band and you have sufficient available funds and we would recommend that you seek advice from Brookson before withdrawing a large dividend.
Alternatively, you could look to accelerate voting of dividend to before April 6th 2016 and avoid the extra tax charge (leaving the dividend outstanding on loan account, of course, to be drawn down in future years). In a small number of cases this may be worthwhile: but great care is needed. This would be because the saving arising from moving back the dividend from the 7.5% rate may be mopped up by the higher rate tax charge in 2015/16.
This would only be beneficial in a small number of circumstances:
1) If you have not drawn your full entitlement to dividends within the basic rate band, then ensuring you do so maximises your income.
2) Where you are already paying tax at the highest rate and expect to continue to do so in future years. For example, if you are drawing dividends of £200,000 a year, you may save £15,000 in tax by voting an extra £200,000 in the current year and reducing dividends by £50,000 in each of the next four years.
3) The third is the special case where your dividend income runs at around £110,000 per year. Accelerating up to £35,000 of dividend from 2016/17 into 2015/16 may afford tax savings of around £5,000 because of the interaction of a number of tax factors at this level of income.
Married or in a civil partnership
If you have spouse or civil partner who is not utilising all of their allowances (be it zero, basic or higher rate) then considering paying dividends to them (you will need to make them a shareholder) can also have a dramatic impact on the amount of personal tax payable on those dividends. This must be structured correctly and the level of dividend paid to them carefully planned so we would recommend that you speak to Brookson for advice.
Company funded pension contributions
If you are currently paying a pension out of net income or don’t already have a pension in place then you should consider setting up a company pension.
The benefits are twofold:
Namely, the corporation tax saving on the pension contribution and the tax on the dividends you are obliged to pay if you were drawing the income personally to contribute.
An annual allowance of £40,000 applies but other than that, there is no restriction as to how much you can contribute tax-efficiently. You can then withdraw up to 100% of your pension at age 55 depending on your circumstances therefore this is an effective plan to implement if you are approaching the age of 55.
You may consider setting up a pension scheme in the current period. If your annual allowance is not fully utilised, there is scope to utilise the shortfall in the next period- in effect, substituting a potential dividend withdrawal with a company pension contribution which would also impact favorably on your corporation tax liability.
However, it is unlikely that contractors will be caught by the new adjusted income rules.
These measures restrict pensions tax relief by introducing a tapered reduction in the amount of the annual allowance for individuals with income (including the value of any pension contributions) of over £150,000 and who have an income (excluding pension contributions) in excess of £110,000.
Positive Directors Loan Account
If you have a positive director’s loan account with the company it is perfectly acceptable for you to charge an appropriate rate of interest to your company- you would receive net interest from the company and the company would settle the income tax portion directly with HMRC.
Limited company buy-to-lets
If you have been considering drawing a dividend to fund a buy-to-let purchase then you would definitely be hit by the new dividend tax rules. You can purchase a buy-to-let using a limited company without the need to draw that deposit out of your company – avoiding all the tax implications that involves. In fact, contractors can now purchase investment properties through a new limited company which is a wholly owned subsidiary of their contracting company, allowing the deposit funds to be transferred between the two companies without a dividend drawdown.
Also, from 2017, mortgage interest rate relief is going to be limited to the basic 20% income tax rate, which will be phased in from 2017 to 2021.
Therefore a personally held property portfolio holder who incurs significant mortgage interest will find themselves paying higher tax rates, thus making company held properties more attractive, particularly if looking to develop a property retention strategy in the company.
Companies will continue to pay corporation tax at 20% on any profits arising, therefore you still have the flexibility to choose to leave profits in the company or withdraw them as dividends. However, you may want to consider leaving funds in the company to build up until you reach retirement, or perhaps if you move in to a permanent role as there are tax advantages, if you meet the criteria, and you decide to close your company in these circumstances.