Structuring Your Business Correctly
The way that a business is set up has significant implications for the amount of tax which will ultimately be payable. Whilst many small businesses still trade as sole traders or partnerships, it is a little known fact that a significant number of these businesses would actually pay less tax and National Insurance ( NI) if they converted to a limited company.
A structure involving both a limited company and an unincorporated business utilises beneficial tax rules relating to Goodwill and can therefore be very tax efficient, especially if anticipating high growth and profitability in the future.
Paying Dividends
The key to this is to ensure that pay and dividends are structured efficiently. Paying a low salary topped up with dividends has been utilised as an effective method of payment for small business owners for a number of years.
From 6th April 2013, the optimum salary for a director/shareholder would be £7,690 p.a. with the maximum amount of dividends payable, without incurring the 40% tax rate, being £30,384. The salary should be paid as a director’s fee rather than as a wage to avoid National Minimum Wage regulations.
Effective Management of Finances
As with most people, the majority of business owners would like to pay off their mortgage at the earliest possible opportunity. However, this may not be tax efficient, as doing so often leads to dividends being taken from the company which could get taxed at 25% or more.
This poses the question: is it wise to incur a 25% cost in order to save interest which can be as low as 1.5%? It is often far more tax efficient to keep funds in the company for as long as possible due to the fact that if the company eventually sells or closes down, the funds can be released after only 10% tax.
Utilise Tax Efficient Investments and Payments
Pension contributions provide tax relief at your marginal tax rate offering the opportunity to make significant savings (up to 60% in tax, subject to the annual maximum of £50k in 2012-13 and 2013-14). You can also take advantage of any unused allowance from the previous three years.
ISAs provide an avenue to generate tax free income with the annual contribution limit being £11,280, of which £5640 can be in cash.
Other tax efficient investments include Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT).
EIS investments provide the opportunity to invest sums of up to £1m and get 30% tax relief if you hold them for 3 years. There is also an additional benefit for an investor who has a CGT liability due to the fact that this can be deferred by investing in EIS and after three years will become exempt.
You can invest up to £200,000 in a VCT which gives you 30% tax relief on the initial investment (if you hold it for 5 years); the VCT is also free of Capital Gains Tax (CGT). After 5 years, you may be able to reinvest your initial investment and obtain a further 30% tax relief.
Utilising Family Tax Allowances
If spouses, children or other relatives are not utilising their Personal Allowances, there exist a number of legitimate ways of ensuring their allowances are still maximised. For example, children can legally work from the age of 13 and this means that children and other relatives are legally allowed to complete basic tasks for your business. However, it is crucial that these activities must be relevant and justifiable.
There are also ways of splitting assets to reduce the tax rate on the income. If you have children aged either 18 or over with a range of skills that may prove useful to the business, you have the option of either paying them as employees or they can form their own company and invoice you.
This can also be a good way of funding university costs, rather than from your own income, taxed at up to 40%.