profit extraction and investment for family and omb businesses - bodmin/redruth

Profit extraction and investment

for OMB and Family

Businesses

7 December 2015

www.francisclark.co.uk

Chairman’s welcome

Brian Harvey

Partner


Housekeeping


What are we going to cover?

• Tax on business profits

• Tax relief on investment back into the business

• Tax on cash extraction

• Tax efficient investment

• Tax on indirect profit extraction / benefits in kind

• Tax on residential landlords


Scott Bentley

Partner


Business structure

Common Structures for a OMB Family Business;

• Sole Trade/Partnership

• Limited Liability Partnership (LLP)

• Limited Company


Tax principles for different structures

• Profits arising in a sole trader or partnership are added to the other sources of income that the sole trader / partner has and tax is charged at personal income tax rates

• Partners in an LLP are taxed as above.

• Companies are not subject to income tax but instead pay corporation tax. Owner managers only pay additional tax if they extract profits from the company.


Tax & National Insurance rates on profits(working age owners)

Further Considerations;

• Corporation Tax Rate to be reduced to 19% in 2017/18, and to reduce further to 18% in 2020/21 so the gap is going to get bigger!

Basic Rate Higher Rate Additional Rate

Sole Trade/Partnership/LLP 29% 42% 47%

Company 20% 20% 20%


So what conclusions can we draw so far?

• If the business needs to retain profits then a company structure offers a much lower tax environment meaning that more profit can be retained.

• Why might we want to retain profits?

- To make debt repayments

- To make capital investments

- To expand the business and grow


Other options for the family business

• Bring family members into business as partners to share profits

• This can help to ensure that profits remain taxed at lower rates without the need to move to a company structure

• Avoids complication of running a company

• If bringing them in as partners is inappropriate are all family members paid properly? Could salaries be increased to ensure better use of “family” tax bands?


But what if you can take all the cash out?

Comparison of tax rates between Sole Trade, Partnerships and Companies where all profits made in a year are to be extracted;

Note This ignores the dividend allowance of £5,000 and sole trader / partnership tax rates include NIC.

Basic Rate Higher Rate Additional Rate2015/16 Sole Trader/Partnership 29% 42% 47%

Company 20% 40% 44.4%

2016/17 Sole Trader/Partnership 29% 42% 47%

Company 26% 46% 50.5%

2017/18 Sole Trader/Partnership 29% 42% 47%

Company 25.1% 45.3% 49.9%


Conclusions

• For higher and additional rate tax payers in service / professional businesses companies look less attractive going forward if you look purely at income tax savings.

• Still beneficial for basic rate payers but benefits eroded and is the complexity worth it?


Investment in the business

• Profits invested back into the business may attract further tax relief depending on what you do with them

• Pay down debt (capital not interest) – no tax relief

• Invest in land and buildings mostly no tax relief but could be some via Capital Allowances on fixtures or other limited reliefs

• Buy plant , vehicles etc there is tax relief in the form of Capital Allowances

• Undertake Research and Development and generous reliefs are available.


Investment in the business on plant and machinery

• Annual Investment Allowance (AIA) is an immediate 100% tax relief for capital expenditure on qualifying plant and machinery used in the business including fixtures in buildings.

• Currently the maximum amount of expenditure in a year that can qualify for AIA in £500,000.

• From 1 January 2016 the maximum is reduced to £200,000.

• Expenditure in excess of these levels receives writing down allowances at rate of 18%/8% on a reducing balance basis unless it is in a separately favoured category such as Environmentally Favoured Kit in which case 100% relief may still be due.

• For periods spanning 1 January 2016 the AIA transitional rules will bite.


Practical steps

• Timing – bring expenditure forwards?

• If you cannot bring the expenditure forward you might improve your position by changing your year end. But remember this is a timing difference and there probably need to be other commercial reasons for a change of year end

• Check that what you are buying does not get a 100% allowance outside of the AIA limit (i.e. environmentally friendly kit)

• If the item concerned is likely to be sold within 8 years think about “Short Life Asset Elections” this can accelerate allowances and will be important going forwards


Capital Allowances in buildings

• Capital Allowances on ‘Fixtures’ in a Commercial Property/Furnished Holiday Let .

• New rules for transactions post 1 April 2014 whereby need to fix the value of “fixtures” between buyer and seller at date of disposal.

• Failure to do so may result in the building losing tax allowances moving forwards.


Other land and property based reliefs

• Generally no tax relief for expenditure on land or on buildings (apart from plant and fixtures therein as already mentioned)

• Business Premises Renovation Allowance (BPRA). Has potential to give 100% tax relief for the renovation of unused business premises in disadvantaged areas. Due to end in March 2017

• Land remediation relief, get 150% relief on clean up costs as long as you didn’t do it! Exception Japanese Knotweed. But for companies only.


Research and Development tax credits

• Companies only.

• For SME’s 230% tax relief for qualifying expenditure.

• SME- Turnover up to 100M Euros, 500 employees, assets 86 M Euros

• If loss making can claim a repayable amount in the sum of 14.5% of the enhanced R & D expenditure.

• Lots more industries coming in particularly food and drink.

• Key question is what is R & D?


So if you don’t need to invest how do you get your hands on the cash?

• As previously outlined sole traders / partners already own profits so there is no concept of “extraction”. They pay tax on profits whether drawn personally or not.

• Conversely, profits belong to a company until they are extracted by a shareholder. Common ways of extraction include;

o Salary

o Dividend

o Interest on loans

o Rental of assets used by the business but owned personally

o Pension contributions

o Benefits in kind (cars etc)


Increase in dividend tax!

Dividends were great!

But is that still the case?

The above are effective rates of tax on net cash drawn.

Old Rate New Tax Rate Increase in Tax

Basic Rate Taxpayer

0% 7.5% 7.5%

Higher Rate Taxpayer

25% 32.5% 7.5%

Additional Rate Taxpayer

30.55% 38.1% 7.5%


Do we still love dividends?

• Dividends have generally always been more efficient that salary

• Why?- Because whilst you don’t get corporation tax relief on them, they are not liable to National Insurance

• The lack of NI and the way that additional corporation tax and the income tax on the dividend combined meant that you retained more cash from a dividend than salary.

• With the extra tax on dividends is that still true?

Dividends are clearly more efficient in this case


Some examples

So lets consider a company has £100 of profit that it is happy to pay to an employee / shareholder. It doesn’t care how it does it as long as the cost to the company is only £100. How much cash will the recipient retain under dividend or salary?

Basic Rate Higher Rate Additional Rate

Dividend2015/16

£80 £60 £56

Dividend 2016/17

£74 £54 £50

Salary £60 £51 £47


However, good news for some!

• From 5th April 2016 a new £5,000 exemption from tax for dividend income

• However, not a massive benefit to the owner manager where most of the profits have historically been extracted by way of dividend

• For a higher rate tax payer the new tax exemption is outweighed by the additional tax once dividend income exceeds approx £22K.

• Consider widening share ownership around the family to gain multiple exemptions? Needs careful thought!


So do we still love dividends?

• Yes we do, just not quite as much!

• Some may make the decision that given the reduction in saving the simplicity of a net wage has appeal

• Other benefits re mortgage applications etc

• Ongoing consultation by government into the taxation of company distributions. So watch this space.

• Possibly different dividend rules for owner / managers

• May target income disguised as capital


New dividend tax

Opportunities

• Pay a large dividend now if the business has distributable reserves?

• Generally we like to delay tax liabilities but for some it may be worth paying less tax sooner!

• Do not forget that whilst the company must have the reserves, this does not have to be paid by the company in cash instantly and can stand on a loan account and paid when cash flow allows.


Interest on loans

• If you lend money to your limited company you can charge interest on it. Maybe an undrawn dividend!

• From April 2016 basic rate tax payers get first £1K of interest tax exempt reduced to £500 for higher rate tax payers.

• Rate charged needs to be commercial but plenty of scope.

• Company will get corporation tax relief and recipient suffers income tax

• Interest even above limit beats dividend (above £5k), so go here first.


Rental of assets owned personally

• In reality probably talking about premises

• Business gets tax relief on rent

• Owner pays income tax

• Beats salary or dividends (above £5k)

• Same tax cost as interest

• However some significant capital taxes issues so think carefully.


Pensions

• Was a dirty word but not any more.

• Company can pay into a pension and generally get corporation tax relief. No personal tax on individual at this point.

• Tax deductible for Company providing the expense is ‘wholly and exclusively’ for the purposes of the trade.

• If aged 55 or over it can be possible to immediately access 25% of the contribution “tax free” without any adverse consequences

• Other funds can then all be accessed at a later date but subject to tax

• Think of the pension scheme as a tax efficient “parking space”


Alan Turner

Chairman/Francis Clark Financial Planning

www.fcfp.co.uk Twitter.com/francisclarkifa

Agenda

• Pensionso Profit Extraction

o Property SIPP

• Tax efficient investment – EIS & VCTo Profit Extraction

o Business Sale

• Summary


Profit Extraction

Options

• Pay the tax and offset the liability somewhere else

• Don’t pay the tax

Pensions


Pensions

Why bother?

• Always been tax efficient

• But previously restrictive;o Inaccessible

o Compulsion to buy an annuity

o Punitive charges on death

• All change!


Profit Extraction - Example

Tax efficient investment

• Company Director receives income of £50,000pa (higher rate tax payer)

• Additional Company profit of £50,000

• Aged over 55


Pensions

Withdraw £50,000 as dividend

• Pay corporation tax on profit; £10,000

• Pay £13,000 as income tax

Or…

Apply £50,000k as salary

• Pay £17,575 as income tax

• Pay total National Insurance of £6,940

Profit extraction

£27,000 net

£25,485 net


Pensions

Or….

• Pay pension contribution of £50,000

• No corporation tax, income tax or NI

On immediate withdrawal…

• £12,500 paid tax free

• £37,500 taxed; £22,500 net income

• But…… future contributions limited to £10,000

Profit extraction

£35,000 net


Property SIPP - Example

Pensions



• Aged over 55

• Has a SIPP in place (value £60k)

• But has not contributed for a few years

• Company owns a business premises


Pensions

Property SIPP • Makes an in specie pension contribution of

the property – valued at £180,000 – to the SIPP

• Care possible corporate tax on the gain• (some would say that’s a convenient figure)• Director now has control over the premises

and the pension fund has a solid return from the rent

• Can withdraw 25% tax free• £60,000 tax free• (also convenient)


Pensions

Property SIPP • And the remaining fund (£180,000) is tax

free on death, too!


Pension reforms – Death benefits

Tax Efficient Investment



• I want to extract funds, not tuck more money away!

• Why would I bother?

• A means to offset tax liability

• With careful planning, cash-flow can be managed

Wait a minute…….


Tax Efficient Investment

Enterprise Investment Scheme (EIS) Venture Capital Trusts (VCT)

• Designed to encourage investment in UK small businesses

• Offer tax incentives – but must be held for minimum period

• Can be ‘Evergreen’

• Recent demand has shown a need for capital preservation and exit opportunity



Income Tax Relief

Minimum Term

Maximum Investment

Minimum Investment

Dividends

Growth

CGT Deferral

IHT Exemption (BPR)

Loss Relief

EIS

30% (plus carry back)

3 years

£1m (each)

c. £20,000

Taxed

Tax Exempt

Yes – no maximum

After 2 years

Yes

VCT

30%

5 years

£200,000

c. £5,000

Tax Exempt

Tax Exempt

No

No

No


Profit Extraction – Example 1





Profit Extraction


Company Profits

£28,625 Net

£11,375 Additional Tax

Liability*£40,625 Net

£12,000 Income Tax Relief

£40,000 EIS or VCT

£40,000 Dividend Paid

*Assumes that £5,000 dividend allowance can be used by the dividend



Business Sale – Example 2

• Trading business started with nothing, then sold for £500,000

• CGT of £50,000 (Entrepreneurs’ Relief)

• £30,000 of income tax paid annually

• Nil rate band (and residence nil rate band) used by other assets



Business Sale

£500k + £36k + £325k + £175k = £1,036,000

to heirs£60,000 Income Tax Relief, less £24k IHT

£500k; CGT deferred and IHT free (replacement business property relief)

£500,000 Other assets

£500,000 Business

£270k + £325k + £175k = £770,000 to heirs

Less £180,000 IHTLess £50,000 CGTSold with no planning

Sold and reinvested in EIS


Summary

• You can withdraw company funds tax efficiently

• With a little planning, tax efficient investments can offset tax liabilities

• And pensions have become the fulcrum of financial planning – for profit extraction and more….

www.fcfp.co.uk

No responsibility can be accepted for any action taken as a result of information contained in this presentation. We therefore strongly recommend that no action should be taken before obtaining detailed professional advice.

Past performance is not a guide to future returns and the value of investments and income from them may go down as well as up and an investor may not get back the amount invested.

Francis Clark Financial Planning is a trading style for Francis Clark Financial Planning Limited, which is authorised and regulated by the Financial Conduct Authority.

Registered Office: Sigma House, Oak View Close, Edginswell Park, Torquay, TQ2 7FF. Registered in England No. 05413603

Exeter Plymouth Salisbury Taunton Tavistock Torquay Truro

This PowerPoint presentation is for general information only and is not intended to constitute professional advice.Though Francis Clark Financial Planning Ltd is confident on its accuracy, no duty of care is assumed to any direct Recipient of this presentation and no liability is accepted for any omission or inaccuracy.

Important Statement

Twitter.com/francisclarkifa


Scott Bentley

Partner


Staff entertaining

• Christmas party?! – Regular, Annual events open to all staff and below £150 per head including VAT per annum are tax deductible for the company and not taxable on the individual. Even if you are a husband and wife company.

• Happy Christmas!


Childcare costs

• New system of childcare support from 1 April 2017

• Government to contribute 20p for every 80p paid into a newly created Childcare Account. Max of £2K per child

• Both parents must work at least 16 hours per week on the living wage current scheme does not require both parents to be working.

• New scheme applies to children under 12 current scheme applies to children up to 15

• New scheme available to the self employed.

• Should you take advantage of current scheme?


Company vehicles

• An emotive subject!

• No income tax liability arises on an employee who is provided with a van and takes it from home to work providing no other private use.

• If there is private use then a fixed rate tax charge applies

• No income tax charge arises on a car used 100% for business purposes but difficult to support!

• Income tax charge arises on a car provided to employee where any private use including home to work.


Company vans

Provision of a Van for employees

• Where private use, tax is based on a deemed charge – 2016/17 £3,170 assessed at the individuals marginal rate of tax.

• Fuel benefit – 2016/17 – £598 where private use of van and private provision of fuel.

• Class 1A NIC (13.8%) payable by the company on the provision of any benefit.

• Tax payable by a basic rate taxpayer in 2016/17 who is provided with a van for private use and fuel - £754.


Company cars

The tax charge arising on the provision of a car is arrived at by multiplying the list price of the car when new by a percentage determined by its CO2 emissions. The appropriate percentage for cars with CO2 emissions figures are as follows;

A diesel supplement of 3% is applied to diesel cars for each level of CO2 emissions in the table above but so that that the maximum levels of 37% and 35% are not exceeded.

CO2 – g/km 2014/15 2015/16 2016/17

0 0% 5% 7%

1-50 5% 5% 7%

51-75 5% 9% 11%

76-94 11% 13% 15%

Each 5g/km Add 1% Add 1% Add 1%

Maximum 35% 37% 37%


Some thoughts on cars

• What is a van? Double cabs ok providing capable of carrying 1000KG

• However Combi vans etc could be questionable.

• As cars get cleaner the percentages are going up for given C02 levels but the list price doesn’t change. So as your car is getting older the tax cost is going up. Older cars in companies generally a bad idea!

• Second cars in families can still make sense, need to look at the numbers.

• Separate charges arise on provision of fuel based on a flat rate of £22,200 from April 2016 multiplied by the relevant percentage. Rarely worth the cost but pay for simplicity?


Residential landlords under attack

• Income tax relief on interest on borrowings used to finance residential lettings is being restricted for individuals.

• Phased in over 4 years from 2017.

• Will restrict tax relief to basic rate

• For individual landlords with substantial borrowings tax increases are significant.


Residential landlords under attack

• CGT to be payable within 30 days of property disposal from 2019.

• 3% additional SDLT for purchasers after April 2016.

• Many looking at incorporation but not straightforward and needs significant thought.

• Availability of finance as a corporate structure will be an issue for many.


Chairman’s closing remarks

Brian Harvey

Partner


(c) copyright Francis Clark LLP, 2015

You shall not copy, make available, retransmit, reproduce, sell, disseminate, separate, licence, distribute, store electronically, publish, broadcast or otherwise circulate either within your business or for public or commercial purposes any of (or any part of) these materials and / or any services provided by Francis Clark LLP in any format whatsoever unless you have obtained prior written consent from Francis Clark LLP to do so and entered into a licence.

To the maximum extent permitted by applicable law Francis Clark LLP excludes all representations, warranties and conditions (including, without limitation, the conditions implied by law) in respect of these materials and /or any services provided by Francis Clark LLP.

These materials and /or any services provided by Francis Clark LLP are designed solely for the benefit of delegates of Francis Clark LLP. The content of these materials and / or any services provided by Francis Clark LLP does not constitute advice and whilst Francis Clark LLP endeavours to ensure that the materials and / or any services provided by Francis Clark LLP are correct, we do not warrant the completeness or accuracy of the materials and /or any services provided by Francis Clark LLP; nor do we commit to ensuring that these materials and / or any services provided by Francis Clark LLP are up-to-date or error or omission-free.

Where indicated, these materials are subject to Crown copyright protection. Re-use of any such Crown copyright-protected material is subject to current law and related regulations on the re-use of Crown copyright extracts in England and Wales.

These materials and / or any services provided by Francis Clark LLP are subject to our terms and conditions of business as amended from time to time, a copy of which is available on request.

Our liability is limited and to the maximum extent permitted under applicable law Francis Clark LLP will not be liable for any direct, indirect or consequential loss or damage arising in connection with these materials and / or any services provided by Francis Clark LLP, whether arising in tort, contract, or otherwise, including, without limitation, any loss of profit, contracts, business, goodwill, data, income or revenue. Please note however, that our liability for fraud, for death or personal injury caused by our negligence, or for any other liability is not excluded or limited.

Disclaimer & copyright