Tax planning for business owners is about making sure that, over the life of the business, you keep as much of what you earn as the law allows. That is not the same as avoiding tax with clever schemes. It means using the allowances, reliefs and choices that Parliament has deliberately provided, in the right order and at the right time. For an owner-managed company, the company and the owner are separate taxpayers, so the best plan looks at both together.
Why owners need a plan, not just a tax return
A tax return reports what has already happened. Planning decides what happens next. By the time the accounts are finalised, most of the useful choices have gone: the company year has ended, the dividend was not declared, the pension contribution was not paid.
The owners who pay the right amount of tax, and no more, are rarely the ones with the most complicated arrangements. They are the ones who talk to their advisor early, every year, with a forecast of the profit in front of them.
Personal tax planning alongside the company
Personal tax planning for an owner-manager starts from a simple fact: the same pound of profit can reach you in several ways, and each way is taxed differently. You can take it as salary, as a dividend, as an employer pension contribution, as repayment of a loan you made to the company, or leave it in the company to fund growth. The question is which combination suits your circumstances this year and over the next few years.
To answer it, an advisor needs to know what the company is likely to earn, what else you and your household earn, your plans for the next few years, and how much you actually need to live on. That is why personal tax planning works best when it is done by the same people who prepare your accounts.
Salary or dividends: how you take money out
Most directors of owner-managed companies are paid through a modest salary plus dividends. The reason is that the two are taxed differently:
- Salary is a business expense, so it reduces the company’s corporation tax, but it can attract National Insurance for both you and the company.
- Dividends are paid out of profits the company has already paid corporation tax on, so they give no corporation tax deduction. For most people they are taxed at lower rates than salary and carry no National Insurance.
The right mix depends on how much the business earns, what else you earn, whether you want to build up entitlement to the State Pension, and whether you need to show a particular income for a mortgage. [VERIFY: current salary thresholds, National Insurance rates, dividend allowance and dividend tax rates]
Two practical points. Dividends can only be paid out of available profits, so a company with losses or insufficient reserves cannot simply pay them. And dividends need proper paperwork, normally board minutes and dividend vouchers, so the record matters as much as the amount.
Employer pension contributions
A pension contribution paid by your company into your pension is usually deductible for corporation tax if it is wholly and exclusively for the purposes of the business, and it does not attract National Insurance in the way salary does. That makes it one of the more efficient ways of moving profit out of the company, and it builds your retirement fund at the same time.
There are limits. An annual allowance caps how much can go into pensions each year with tax relief, unused allowance from earlier years can sometimes be carried forward, and the allowance can be reduced for higher earners. [VERIFY: current annual allowance, carry-forward rules and any tapering]
Pension planning also depends on your age, your other savings and when you want to stop working, so it should sit inside a wider plan. We can explain the tax side. Advice on what to invest in has to come from an authorised financial adviser.
Family involvement: use with care
If your spouse or another family member genuinely works in the business, paying them a fair salary for the work they do is legitimate and can make use of their personal allowances. The key words are “genuinely” and “fair”. The pay should match the work and the hours, and you should keep records of what they do.
Giving shares to a family member so that they receive dividends can also work, but it needs care. HMRC’s rules on “settlements” can apply where income is in effect redirected from the person who earns it to someone who pays less tax, particularly where the new shareholder does not work in the business. Shares also carry rights over votes, dividends and the value of the company, so the questions of control, divorce and what happens on death matter as much as the tax. Take advice before giving shares to anyone.
Company cars, mileage and benefits
A company car is taxed on the employee as a benefit in kind, and the company pays National Insurance on it. The cost depends on the car’s list price and its emissions, so a low-emission or electric car can cost far less in tax than a conventional one. Using your own car for business and claiming mileage at HMRC’s approved rates avoids a benefit charge altogether and can be simpler where business mileage is modest. [VERIFY: current company car tax percentages and approved mileage rates]
Other benefits, such as private medical insurance or private use of fuel, each have their own tax treatment. Loans from the company to a director are worth special attention: if a director’s loan account is overdrawn when the company year ends and is not repaid in time, the company can face an additional tax charge. [VERIFY: current rate of the charge and the repayment window]
Planning around the year end
There are two year ends to think about: the company’s accounting year end, and the personal tax year, which ends on 5 April. [VERIFY: dates]
Before the company year end, it is worth deciding:
- whether to make an employer pension contribution
- whether to pay a bonus or change salary
- whether to buy equipment, which may qualify for capital allowances [VERIFY: current annual investment allowance]
- what dividends the profits will support
- what the director’s loan account looks like
Before 5 April, it is worth looking at the dividends and salary taken in the tax year, any unused pension allowance, any capital gains to realise or defer, and the allowances available to your spouse or partner.
The simplest habit that helps is a profit forecast around three-quarters of the way through the company year. It leaves enough time to act while the choices are still open.
Business Asset Disposal Relief in outline
When you sell shares in your trading company, or business assets, you may pay Capital Gains Tax on the gain. Business Asset Disposal Relief can reduce the rate of tax on qualifying gains, up to a lifetime limit, if conditions are met. The conditions typically cover how long you have owned the shares, whether you have been an officer or employee, and the proportion of shares and voting rights you hold. [VERIFY: current BADR rate, lifetime limit and qualifying conditions]
The relief has been changed several times, so do not assume it will look the same when you come to sell. Because the conditions are tested over a period, early planning matters. Our guide to selling a business covers the sale itself.
Planning that goes wrong
Be wary of any arrangement that promises to cut your tax by much more than ordinary planning would, involves loans from third parties or offshore structures, or asks you to keep it confidential. HMRC challenges many such schemes and can look back over several years, and some leave people with a bigger bill than if they had done nothing. A good test is to ask the person recommending it to explain the commercial purpose in plain English. If they cannot, walk away.
When to review your tax planning
Review it at least once a year, ideally two or three months before the company year end. Review it again when:
- profits rise or fall significantly
- you plan to change how much you take from the company
- you buy or sell a property or a business
- you bring a family member or partner into the business
- you are thinking about selling or retiring
- there is a Budget or a major change in tax rules
How KSBA can help
We review owner-managers’ tax position every year as part of our accounts and tax work, using your actual figures and a forecast for the year ahead. We explain the options in plain English, agree a fixed fee before work starts, and put the plan in writing so you can see what we recommend and why.
If you would like to talk it through, see our page on business advisory in Manchester or call us on 0161 835 2323.
Talk to us about business advisory
Related guides
- Selling Your Business: A Guide for Owner-Managers
- How to Make Sure Your Business Is HMRC Compliant
- How to Choose an Accountant for Your Business
This guide is general information, not advice for your situation. Tax rules change and the right answer depends on your circumstances, so speak to an advisor before you act.