There Are No Stupid Questions: Tax Planning For Business Owners

Attivo’s mission is to answer questions about Lifestyle Financial Planning with direct explanations. This issue, Delwyn Eatwell talks about business tax planning.

For businesses, tax planning is extremely important as it can help reduce tax bills. In doing so, this can unlock additional funds to invest in expanding their operations, hiring more people and enhancing products and services. In this article, Delwyn Eatwell, one of our Chartered Financial Planners, offers expert advice about tax planning for business owners.

Delwyn says: ‘We have a great deal of experience in understanding the co-relationship between company taxation and personal taxation. This expert knowledge enables us to work closely with a company’s accountants to devise the best profit extraction plan for our clients.’

Q What is profit extraction, and why is it important?

A In short, profit extraction means turning the hard work undertaken by business owners and delivering personal wealth to them in the most tax-efficient way possible. So many business owners spend years working very hard at their businesses, with large amounts of profits being paid out in taxes.

Q Why not leave profits within the business?

A So many business owners have given their all to building their companies, often over many years. A large amount of the profits is then being paid out in tax, some of which can be mitigated with the proper tax planning. These are the areas we highlight to owners of Limited Companies:

Ongoing taxation

In addition, Corporation Tax rates have increased to 25% for companies with profits over £250,000.

Taxation on the sale of the business

Until April 2020, it was possible to claim Entrepreneurs’ Relief upon selling a trading business. This meant that each shareholder would pay a reduced Capital Gains Tax rate of 10% on the first £10m on the company’s sale proceeds.

This was changed on 6 April 2020 to Business Assets Disposal Relief, and the amount was reduced to £1m, meaning that the entire Capital Gains Tax rate of 20% is now payable above this amount.

Therefore, retained profits within the company for a prolonged period tend to build up further taxation issues at the point of sale.Although retaining an element of profits is good business practice, well-planned and structured profit extraction can save a substantial amount of tax both on an ongoing basis and in the future.

The effect of inheritance tax

Many people don’t realise that the assets within their business can be taxable on their death. Depending on how much is in the business and the value of your estate, you could lose up to £350,000 of your Inheritance Tax allowances. In most cases, your business value should attract Business Property Relief as long as you have owned the shares for more than two years at the date of your death. This means your estate will receive 100% relief on the value of your business against Inheritance Tax.

This does not mean, however, that your beneficiaries will not pay any Inheritance Tax on the value of your business. The value of your business will be added to the value of your estate to calculate the amount of Residential Nil Rate Band that you will be able to claim and could potentially wipe it out completely, leading to the potential of an additional £140,000 being payable in Inheritance Tax by your beneficiaries. It is assumed that both RNRB allowances are available and that the deceased’s estate is over £2m, thereby a taper threshold applies.

Q What solutions are available to my business?

A There are several areas that can be looked at to ease the tax burden:

Maximising pension contributions

Currently, the annual allowance for pension contributions is £60,000, with the full amount being available for employer contributions with no link to personal earnings.

In addition, any amount of unused allowance from the previous three tax years can be carried forward as long as specific criteria are met. For example, if a husband and wife are the company’s owners, total pension contributions over three years could be made of £180,000 each, totalling £360,000. If the company’s Corporation Tax is payable at 25%, this would lead to a Corporation Tax saving of £90,000 (subject to both husband and wife meeting the requirements for unused allowances).

The funds then benefit from the additional tax advantage provided by pensions and will not be part of your estate for Inheritance Tax purposes. This is now even more attractive following the recent abolition of the Pension Lifetime Allowance.

Consider a small self-administered scheme (SSAS)

In certain circumstances, 50% of the value of your pension fund can be loaned back to your company as long as it is to be used for business purposes, with positive tax outcomes all round. For example, an owner of a company who has made considerable profits with their business and wants to expand without paying a huge amount of Corporation Tax. The owner and their partner a joint Director of the company, have recently paid £360,000 into their pension pot and have received £90,000 in tax relief. The pension fund is now returning this money to the company, which will be repaid over five years.

In this instance, they have benefitted from the tax relief and have money to fund their company’s growth. It only works in some instances; it’s not straightforward, and strict rules need to be discussed in detail with your Adviser. But it’s very lucrative for the business and the owners when it does work.It’s important to note that there are very particular circumstances for this kind of project and that if you’ve lent the money from your pension to the business and the business can’t pay it back, you’ve potentially lost your business and your pension. Not something that should be done lightly.

Other options

Sometimes, pensions are unsuitable, possibly because the business owner has reached the upper limit of their contributions. Instead, several specialised investments are available, such as Venture Capital Trusts and Enterprise Investment Schemes, which are income tax efficient. These allow you to increase the dividends you withdraw and reclaim a large part of the extra Income Tax that would generally be payable. These investments can be tax efficient across several types of tax liability. Consult your Adviser for the most up-to-date information on this area.

Tax planning is not an activity regulated by the FCA. The value of investments may fall as well as rise. If you have any questions, please email our Client Services team on clientservices@attivo.co.ukor call us on 01242 585444.

Jargon Buster

‘WORKING CAPITAL’: Working Capital is calculated by subtracting a company’s liabilities from its current assets. Liabilities might include, among other things, tax, wages and interest owed on loans.

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