In the UK, small business owners provide a living for a large proportion of the population. According to the UK government, 16.7 million people were employed by small and medium-sized enterprises (SMEs) in 2023 – more than 60% of the total workforce.
However, while business owners are good at providing financial security for others, they often don’t take care of their own finances as well as they could. With that in mind, here’s a look at how UK business owners can extract profits from their companies tax-efficiently and gain more control over their personal finances.
1. Pension contributions
There are several profit extraction strategies that can help business owners in the UK be more tax-efficient. By far, the most effective way is making contributions to a pension.
The reason this strategy is so effective is that pension contributions are an allowable business expense. This means that they can save a business up to 25% in Corporation Tax. Additionally, they are not subject to National Insurance Contributions (NICs), saving another 13.8% in tax. So overall, a business owner can potentially save up to 38.8% in tax by making pension contributions from their company instead of taking the money as salary.
The tax savings don’t stop there. By paying into a pension, a business owner can avoid paying tax on dividends and personal NICs on salary. Any money within a pension is also typically sheltered from Inheritance Tax (IHT), meaning this strategy can potentially help with estate planning. As for Income Tax, this is essentially deferred as you’ll only pay it when you take the money out of your pension in retirement. This could lead to tax savings too though. That’s because there’s a good chance your Income Tax rate will be lower in retirement. According to research from the Centre for Policy Studies, six out of seven higher-rate taxpayers are not higher-rate taxpayers in retirement.
You can pay as much money into your pension from your business as you like, provided the payments meet HMRC’s ‘wholly and exclusively’ test. This states that contributions must be reasonable, and not exceed the company’s annual profits. Note, however, that employer contributions count towards your annual pension allowance, which is currently £60,000. In other words, if you were to contribute more than £60,000 in a tax year, you’d have to pay tax on the excess (you may be able to contribute more than this using ‘carry forward’ rules).
Of course, the one downside to this approach is that your money is going to be locked up in your pension until at least age 55 (57 from 2028). So, it may not be so helpful if you require access to the money in the short term.
2. Dividends
This brings us to dividends, which can be a relatively effective profit extraction strategy if you need the capital now. Dividends are payments made to shareholders from the profits of a company after Corporation Tax has been accounted for.
There are two main advantages of taking company profits as dividends. One is that neither the company nor you as the owner will have to pay NICs on them (assuming you keep your salary below NI thresholds). The other is that your personal tax liabilities are likely to be smaller because the tax rates on dividends are lower than the tax rates on regular income.
For 2024/25, tax rates on dividends are:
- Basic-rate taxpayer – 8.75%
- Higher-rate taxpayer – 33.75%
- Additional-rate taxpayer – 39.35%
This compares to regular Income Tax rates of:
- Basic-rate taxpayer – 20%
- Higher-rate taxpayer – 40%
- Additional-rate taxpayer – 45%
You can also earn up to £500 in dividends for the 2024/25 year tax-free. Therefore, paying yourself dividends can save a substantial amount of tax. It’s worth noting, however, that the most tax-efficient way to pay yourself as a business owner is usually to take a combination of a low salary and dividends. If you’re unsure about the optimal mix here, it can be worth speaking to a tax expert.
3. Holding companies
Looking beyond pension contributions and dividends, another tax-efficient profit extraction strategy to consider is setting up a holding company. A holding company is an entity designed to own assets, investments, and interests in other companies, rather than provide goods and services itself.
One major attraction of holding companies is that assets from subsidiary companies can be transferred into them without being subject to tax at the point of transfer. Dividends received by holding companies from subsidiaries are also exempt from Corporation Tax. This means that these structures can offer opportunities to reduce tax.
A holding company structure may also enable a trading subsidiary business to be sold tax-free. If the holding company has owned at least 10% of a subsidiary company’s shares for at least 12 consecutive months during a two-year period prior to the disposal, the shares can be disposed of without a Corporation Tax liability. This is known as the Substantial Shareholding Exemption (SSE).
It’s worth pointing out that establishing a holding company can have other benefits. For example, holding companies allow business owners to protect their assets by shielding them from subsidiary company risks. However, it’s important to note that holding companies can be a complex area of tax planning, so it’s always sensible to get advice from a professional if you’re thinking about setting one up.
How Bowmore can help UK business owners with profit extraction
In conclusion, there are a number of strategies that UK business owners can employ to extract profits from their companies tax-efficiently. From making pension contributions to setting up a holding company, these strategies can be used to maximise an owner’s wealth while ensuring the company’s continued success.
However, before moving forward with a profit extraction strategy, it can be worth speaking to a financial adviser. An adviser will take the time to assess your current and future income needs and help you determine the most tax-advantageous approach for your specific circumstances.
At Bowmore, we have decades of experience helping small business owners build wealth outside their companies. We understand the challenges business owners in the UK face, and we can help you navigate them.
To find out more about how we can help you with tax planning, get in touch.
BOWMORE FINANCIAL PLANNING
Phone: 01275 462 469
- Bowmore Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority.
- Bowmore Financial Planning Ltd is not regulated to provide tax advice.
- The Financial Conduct Authority does not regulate Estate Planning or Inheritance Tax Planning.
- A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.
