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Cash extraction

For privately owned companies, it's always hard to choose the best way to extract cash and value from your business.

FLB recognise that the requirement to extract cash for business owners varies significantly from business to business. While some business owners have sufficient income from their non-business assets such as rental properties, others may need an income stream from the business.

In addition, one off lump sum cash requirements may arise from time to time. There are a number of factors which need be taken into account when extracting value from a company.

The company will need to have cash in the bank before it can pay cash out to the shareholders and the level of cash available will depend on the profile of the business. More mature businesses are likely to have cash reserves while growing businesses may have all of their cash tied up.

When considering how to extract cash from a business, one consideration is the tax costs that arise on the extraction. Tax legislation in general makes it expensive to extract money from a business and careful planning is required to try and minimise these taxes.

We work with you firstly to understand what you need in terms of cash flow, capital expenditure and contingencies and then will advise you on tax efficient cash extraction options to help your business.

The most important methods of income extraction are as follows:

remuneration (including benefits in kind)
pension contributions
dividends
loans from the company
interest on loans to the company
rent on personally owned property used in the company's trade.

In addition, some extractions can be structured as a capital gain. These include:

selling assets to the company for value
purchase of own shares
liquidation of the company.

Some gains may qualify for Entrepreneurs’ Relief (ER) which means a 10% rate of capital gains tax and is therefore highly attractive.

However, such capital extraction methods are only usually available at the beginning or end of an individual’s involvement with the company and HMRC have some nasty rules for the unwary, so advance planning is crucial.

For an individual who has ongoing involvement in the company, the main income extraction options are reviewed below:

Dividends vs. Bonus

Dividends continue to be more tax efficient than bonuses in most circumstances, due to the fact that the corporation tax deduction does not outweigh the added national insurance (NIC) costs of providing cash remuneration. This is particularly attractive for companies that pay the small rate of corporation tax currently at 20%.

It is therefore essential that, if dividend extraction is required, attention is paid to company law procedures to ensure that the dividend is lawful. For dividends to be lawful they must meet two conditions:

the company must have sufficient profits to finance the dividend and
the dividend paid to shareholders must be paid according to the terms laid down in the Articles for that type of shareholding.

Benefits

Certain benefits are tax and NIC free and should not be overlooked. In addition, tax relief on their provision is usually available to the company.

Examples currently include:

cars and vans which don’t emit CO2 emissions
childcare vouchers
the provision of a car parking space at or near the employee’s normal place of work
the provision of bicycles and associated safety equipment for mainly home-to-work travel
a mobile phone
employer pension contributions.

Loans

Making a loan for a temporary period to a director/shareholder does have a number of taxation implications but can be used effectively. For the company, where loans are outstanding more than nine months after the accounting period end, the company will have to pay a 25% tax charge. However, this will eventually be refunded when the loan is repaid or written off. For the individual, they will be assessed on a benefit for the use of the funds at the official HMRC interest rate, currently 4% of the loan balance annually. The employer will be charged with Class 1A NIC on this element.

However, compared to awarding a bonus or declaring a dividend there may be a tax saving, especially for those in the 50% tax band.

Loans to the company

Loans to the company may provide another route for extracting profits from the company through interest receipts rather than dividend receipts. The company will usually receive a corporation tax deduction for the interest accrued.

However, if the interest rate is more than a ‘reasonable commercial return’ the excess is treated as a dividend and so the excess is not tax deductible.

The company is normally obliged to deduct 20% tax at source on interest paid to individuals and account for it to HMRC (just like on interest paid by the banks).

Pension contributions

Pension contributions are tax efficient for both employers and employees/directors. From the individual’s perspective employer contributions are generally tax and NIC free. However, those with incomes of £130,000 or more in 2010/11 or in either of the previous two tax years should take advice before making contributions due to targeted anti-forestalling rules. Recent announcements for 2011/12 may also impact substantially on the tax efficiency of significant employer pension contributions for all levels of earners in future tax years so again advice is recommended before action is taken.

From the employer’s perspective tax relief is normally available with no employer NIC cost, provided the overall remuneration package is justifiable.

Pension contributions must be paid in the period for a corporation tax deduction to be obtained for the same period.

Using family members

Employing family members or running the company in tandem with them can be a very useful way of both spreading the tax burden within the family and obtaining a business tax deduction. Consideration should always be given to whether the overall package is reasonable and commercial for the value of the work undertaken.

Charging rent on personally owned assets used by the company

Where a property is held outside the company, the proprietor can extract funds from the company by charging up to a commercial rent. The rent paid by the company is deductible against its profits and is taxable in the proprietor's hands. The tax effect is therefore similar to paying remuneration except that no PAYE or NIC is payable.

In many cases the proprietor will have borrowed to purchase the property. The rental income received will ensure immediate tax relief for the resulting interest paid, which can be deducted against it along with other rental expenses.

As you can see, there are many options available to owner managers but each has different consequences. If you would like to us review your current situation or discuss your personal options in more detail, please do get in touch.