5 ways for businesses to save tax by 5 April 2017
As 5 April approaches, Donald Drysdale explores some tax planning opportunities for those in business.
The need for advice
In my previous article I considered steps which individual taxpayers might take by 5 April to minimise their tax liabilities. There is much for practitioners to do to ensure that appropriate advice is given in time for it to be acted upon.
For clients in business, whether self-employed or as shareholders, directors or employees of companies, additional tax planning considerations apply. Many business tax deadlines arise at times other than 5 April – for example, by reference to the accounting date, or on anniversaries of certain transactions.
Nonetheless, the approach of the end of the fiscal year is a useful time to review tax planning strategies, not only to save business taxes but to support tax-saving measures by others such as directors, employees and investors.
1. Salary versus dividend
Owner-managers of family companies may seek to plan the scale and timing of dividends to optimise the use of shareholders’ dividend allowances. From 6 April 2016 a tax-free dividend allowance of £5,000 is available to each individual. Dividend income above that amount is treated as the top slice of income and taxed at 7.5%, 32.5% and 38.1% within the basic, higher and additional rate bands respectively.
In 2015/16 and earlier years, it was generally attractive for owner-managed companies to pay modest salaries and then distribute surplus profits by way of dividend, as this saved income tax and (more especially) National Insurance Contributions (NICs). However, the new dividend tax regime has fundamentally altered the relative merits of salary and dividends as alternative means of extracting profits.
In broad terms, the impact of the new dividend tax rates is to ensure that, for a higher rate or additional rate taxpayer who has already used their £5,000 dividend allowance, the combined marginal rate of income tax and NICs on additional salary will equate with the marginal rate of income tax on additional dividends.
Determining the optimum balance between salary and dividends requires a detailed evaluation of the impact on the company and everyone. In cases where this has not been addressed already, the period between now and 5 April may be the final chance to get it right for 2016/17.
2. Pension contributions
Profits can also be extracted from an owner-managed company by paying pension contributions on behalf of one or more directors or employees. An employer can contribute in this way without the payments being treated as benefits in kind.
Pension contributions paid wholly and exclusively for the purpose of the company’s trade, and with no identifiable non-trade purpose, are generally deductible in computing the company’s corporation tax liability – though not necessarily in the accounting periods in which they are paid.
There is no limit on the amount that can be invested in an individual’s pension schemes, but there are limits on the amount of tax relief available. While directors and employees may welcome contributions paid on their behalf, they need to understand the annual allowance charges and lifetime charges they may face personally.
When aggregate contributions by the individual and anyone else (for example, their employer) exceed the individual’s annual allowance, they will suffer an annual allowance charge – taxed as additional income for that year. Depending on circumstances, the current annual allowance ranges from £10,000 to £40,000 and may be augmented by unused annual allowance brought forward from the previous three years. If tax on an annual allowance charge exceeds £2,000, it may be paid from the pension pot.
If an individual has an aggregate pension pot worth more than the lifetime allowance, currently £1m, they may face tax on a lifetime allowance charge on drawing benefits. This tax is at 55% on lump sums or 25% on other payments. There are a number of different ways an individual may be able to protect their pension from reductions to the lifetime allowance. For Individual Protection 2014 the latest date on which a claim can be made is 5 April 2017.
Although pensions are usually considered in a business or employment context, this is not always the case. Pension contributions can be made by or on behalf of any UK residents, even minors, to invest funds in a tax-free environment. In the absence of earnings, the first £2,880 of net contributions paid each tax year qualify for tax relief at 20%.
3. Salary sacrifice
The draft Finance Bill 2017 provisions, at clause 2 and Schedule 2, propose new restrictions from 6 April 2017 on the income tax and NIC advantages of providing benefits in kind through salary sacrifice arrangements. Salary sacrifice (if set up correctly) will still work for arrangements that provide certain benefits – namely, pensions saving, employer-provided pensions advice, childcare, ‘cycle to work’ and ultra-low emission cars (under 75 g/km).
Where agreements made before 6 April 2017 remain unchanged, the new restrictions won’t apply until 6 April 2021 on those relating to other cars, employer-provided accommodation or school fees, and until 6 April 2018 on all other benefits. This creates a brief opportunity to set up new arrangements before 6 April 2017 to secure tax and NIC savings through either of these transitional periods. However, any change made after 5 April 2017 to a salary sacrifice arrangement will disqualify it from transitional relief.
4. Tax-advantaged investments
At this time of year certain companies may be well placed to raise additional capital, as individuals try to shelter high personal incomes or capital gains by making tax-advantaged investments.
An investor subscribing for eligible Enterprise Investment Scheme (EIS) shares newly issued by a qualifying company may obtain 30% income tax relief at the outset and exemption from capital gains tax on eventual disposal (normally after three years). If other capital gains are realised and invested in EIS shares, a claim to defer the capital gains tax may be made.
The Seed Enterprise Investment Scheme (SEIS) is aimed primarily at helping small start-up companies. It is based broadly on EIS but offers investors the possibility of 50% income tax relief, capital gains tax exemption and capital gains tax reinvestment relief.
Social Investment Tax Relief (SITR) is available to individuals who subscribe for qualifying shares or make qualifying debt investments in a social enterprise. Income tax relief is available at 30%, and capital gains tax disposal and deferral reliefs are also available.
Each of these schemes requires different, stringent conditions to be satisfied. Note that the amount of SITR investment an enterprise may receive is to be increased but the scope of the scheme is to be narrowed with effect from 6 April 2017.
5. Disincorporation relief
It is only a year until the planned withdrawal on 31 March 2018 of disincorporation relief, which allows certain companies to transfer goodwill and interests in land to their shareholders on disincorporation without corporation tax liabilities arising.
Proprietors of small companies might want to consider taking advantage of this relief. The relative merits of operating through a company or as an unincorporated business may have altered since the company was set up – not least because of the new dividend tax regime.
Article supplied by Taxing Words Ltd