Tax planning for business owners

Choice of accounting date – sole traders and partnerships

  • The choice of accounting date affects the delay between earning profits and paying tax on those profits. When profits are static this delay is not an issue, but when profits are rising this provides a useful cash flow benefit. However, when profits are falling this can make tax payment difficult if business needs have eroded cash that might have been set aside to pay tax.
  • An accounting date early in the tax year is a benefit for a growing business, but current economic conditions mean that some businesses might benefit from a change in accounting date to ensure that lower profits come into charge earlier, reducing tax payments. Of course as profits rise again, this might not be attractive, and businesses are not permitted to change accounting date more than once every five years unless it is for genuine commercial reasons.
  • The accounting date of a company does not affect the interval before tax is due on the profits as corporation tax is always due for payment nine months after the end of the year, except by the very largest companies.

More than one business?

  • When you have several business interests it is important to be aware of the tax implications when setting them up. The structures that you put in place can affect the tax liabilities on the business profits.
  • When two companies are under common ownership (including companies owned by spouses and civil partners) the small company limits for corporation tax are shared between them. This makes it very much more likely that a successful business will pay the marginal rate of corporation tax (currently 29.75%) on profits. For example, although the limits are £300,000 for the small company rate, if there were three associated companies, each would only benefit from £100,000 of profits at the small company rate. Two of the companies might only make small profits of around £10,000 per annum, but the third successful company making £250,000 would suffer the higher rate of tax on £150,000 of those profits, in spite of the fact that between the three companies the £300,000 limit has not been exceeded.
  • Where related companies are sharing the limits in this way there is still no possibility of offsetting losses between them, so this could be viewed as the ‘worst case scenario’. Forming a small group of companies would at least allow the losses in one to be offset against profits in the others.
  • It is important that you consider the structure of your business interests on a regular basis to ensure that you have the best outcomes for your business and you.

Extracting profits from a company

Whether you are considering extraction of profits from a company on a tax year basis or aligned to the company year end, there are a number of issues that should be considered.

  • Salary: National Insurance contributions are expensive but salary can be deducted from taxable profits in the company, so if profits are taxed at the marginal small companies rate (currently 29.75%), there is very little difference between extracting profits by way of salary or dividend for higher rate taxpayers.
  • Bonuses: where annual bonuses are payable, the bonus must be due and payable before the company year end, even if the specific amount has not been decided. This is necessary to benefit from tax relief against the profits of the period. The bonus must always be paid within nine months of the year end to secure the tax deduction in the company. Where bonuses are normally paid annually, you might wish to consider the implications of the higher rates of tax applying in 2010/11 and accelerate bonuses into the current tax year if appropriate.
  • Dividends: the current effective rate of tax on a cash dividend is 25% of the amount received. This is payable as part of the self assessment liability for the shareholder. Next year the tax on a cash dividend will rise to 36.1% if the dividend falls into the 50% tax rate band (for taxable income over £150,000). Again, accelerating substantial dividends into the current tax year might be appropriate.
  • Benefits in kind: some benefits in kind are still quite tax efficient, including the provision of a company mobile telephone and a car with emissions of no more than 120g/km of CO2. In fact if the car has emissions of no more than 110g/km it will also attract 100% first year allowances in the company in the year in which it is purchased new. (The allowance is not available on second hand cars).
  • Pension contributions: the same test applies to pension contributions for director shareholders as applies to the spouse of a shareholder/director. Provided the total salary package (ignoring dividends) is reasonable for the input of the director into the company, then all salary plus pension contribution should be allowed against profits for tax purposes. Remember that there is an annual limit on pension contributions, which is currently £245,000. Contributions in excess of this will trigger a tax charge on the member at a rate of 40%. You will also need to take care if your income is in excess of £150,000. From 2011 company pension contributions will be regarded as part of the salary package for those with income in excess of £130,000, so you may wish to make contributions now to top up your pension, subject to the anti forestalling rules.