Getting the most from your Limited Company
Although contracting through your own Limited Company is generally accepted as the most likely model to provide contractors with the maximum take home pay, careful planning is also required to ensure you get the most from contracting. But how do you make sure you’re exploring all of the available opportunities?
In this ebrief we look at the whole range of considerations you should review to help plan your future. They illustrate how best to keep ahead and structure your company and the income taken, or retained within it to your best advantage
Specifically we focus on:
- getting the most from your Limited Company
- first steps – what to consider when starting out
- understanding IR35
- tax efficient salary
- spouse’s salary • dividends
- classes of share
- if you should take loans
- surplus income
- income or gains
- family income companies
- company liquidations
- and finally… achieving your aspirations
Getting the most from your company
The trick to getting the most from contracting through your Limited Company is knowing what your aspirations are, setting out a plan and then monitoring your progress towards achieving your goals.
Efficiently extracting your basic, day to day, income should be one of your most important aspirations. There is no point focussing on tax at this stage, as you need to begin by understanding what cash you actually need from the company every month.
Preparing a personal finance budget is a great way to start, as this will set out the net of tax take home necessary to fund your regular living expenses. Once you have established how much you need then you can start thinking of how to efficiently take that money from the company.
For all Limited Company contractors, understanding your IR35 status sets the scene for how best to take money from your company. If you fall within IR35 then your tax is determined by those rules. Your company will be taxed as if all its income is paid to you as wages, regardless of whether or not you take that money from the company. But, if you are outside IR35 then you have a number of flexible routes to explore.
Most contractors understand that taking a low wage that’s topped up with dividends is generally the most tax efficient way to take money from the company. Your specialist Personal Accountant will be able to provide you with expert, tailored advice that’s unique to your circumstances, on how to maximise your take home pay through the taking of dividends.
Tax efficient salary
Many contractors take a basic salary of around the same level as their personal allowances. Provided these are not substantially affected by other income, benefits or underpaid tax then your tax free pay is a good place to start for your basic wage.
If your spouse or partner does not make full use of their personal allowances, then provided they do some work for the company, (such as bookkeeping, invoicing and general administration), an appropriate wage can also be paid to them. Most contractors consider the National Insurance threshold as an indicator, but there is no reason why personal allowances cannot follow the same guide.
The new dividend tax means some careful planning is appropriate. The first £5,000 of dividends are entirely tax free, therefore having two shareholders can mean a maximum of £10,000 can be taken with no tax payable. Higher dividends are then taxed depending on whether they fall within the basic, higher or additional rate bands. Again having two shareholders helps limit the extent of higher or additional rates of tax payable.
Dividend Rate of Tax, for dividends falling within:
- Nil Rate Band (£5,000) …….0.0%
- Basic Rate band……………….7.5%
- Higher Rate band…………….32.5%
- Additional Rate band……….38.1%
Classes of share
Dividends are paid to shareholders directly in the proportion of shares they hold. This can create difficulties if you need to vary the amount of dividend each person receives without having to transfer shares between them. So to overcome this, it can be more convenient to create two distinct classes of share and having each person hold their own distinct class. This enables separate dividends amounts to be declared on each class and you can then direct the most appropriate amount to each shareholder.
Creating separate classes must be carefully considered. You have to make sure that you have done it right and that some of the tax pitfalls have been avoided. Speak to your Personal Accountant to get this part right.
Making the most of the basic rate band
If your cash needs exceed the basic rate band, and you have more than one shareholder, then make sure income absorbs the basic rate band of each shareholder if you are happy to share earnings with them. There would be little point in one shareholder paying higher rates of income tax if the other could still receive income taxed within their basic rate band.
Should I take loans?
Loans from a company are taxed if they remain outstanding after a specific time limit (nine months after the end of an accounting period). The rate of tax is the same as the tax payable on higher rate dividends, that’s 32.5%. But that does not mean that loans cannot be used to move dividends from one year to another and avoid higher rate taxes.
You wish to purchase a special something, outside of the normal course of business. This means you need to take money from the company that will be taxed at the higher rates. Normally your income needs are less than your basic rate tax band, but, rather than save up over a couple of years you want to make this purchase now.
You could take higher dividends which would be subject to higher rate tax, or alternatively you could borrow the required money from the company and then repay from future dividends, taxed within the basic rate, in the year they are taken. Provided you get your dates right, using loans can help delay taking a dividend until a later tax year, when tax rates are not at the higher rate of 32.5% but the basic rate of 7.5%.
Your Personal Accountant will be able to advise you further with tailored advice to your circumstances.
Limited Company contractors benefit from higher income levels and greater tax efficiency. This means that they often create more income than they need and have a choice to accumulate that surplus within the company. After all, why take the surplus income personally and suffer dividend tax when you don’t need to.
What can your company do with its surplus income?
A company is pretty much able to do everything you do. Of course there are some exceptions for example a company cannot own Premium Bonds, or make use of ISA’s and other personal tax advantaged investments, but it can own Buy to Let property, commercial buildings or buy shares, bonds or even invest in other businesses.
It often makes sense to invest surplus income in your company, because by not incurring higher personal taxes you are investing more money, with the expectation of earning a return on the cash that was not required to pay the tax ! Any income earned by the company investments is subject to Corporation Tax at lower rates than income taxes.
Income or Gains
The decision on whether or not to invest personally or in the company can be a complex decision and depends on your individual personal circumstances and whether you expect income or capital gains.
For companies, income and gains are taxed at Corporation Tax rates which are generally lower than the income tax or capital gains tax you will pay personally.
If your aspirational plans include investing surplus money, then you must always talk to your financial adviser to make sure you invest sensibly, with the right mix of risk, and your specialist accountant to help you make the right decision based on tax considerations.
Type of investments
Typical investments made by contractors Limited Companies include:
- Listed and unlisted shares
- Bonds and Debentures
- Unit Trusts and Funds
- Government securities
- Residential property
- Commercial property
- Longer term investment bank accounts
- Cloud funding
Family Income Companies
Your Limited Company is a normal trading business and has commercial risks attached to it. Those risks could materialise into liabilities that could potentially hurt your accumulated surpluses.
To avoid this, surplus income can be extracted using share classes and dividends into a separate company, free of any commercial risks from contracting. Making investments in this second company separates your potentially risky contracting activities from your investment activities.
Contractors are beginning to recognise the opportunities that a second company has in future planning. This additional company could be established with wider family shareholdings and be used to accumulate wealth to be distributed to the wider family in the longer term. This is typically referred to as a family income company.
Recent changes in tax laws mean that accumulating surplus income within the company, with a plan to liquidate and release all the accumulated value in the company subject to Capital Gains Tax and Entrepreneurs’ Relief, has been restricted in some circumstances.
If you were planning to build a surplus to be released by liquidation and you expect to continue working, then you may be caught by these new rules. The effect would be to tax your surplus as dividends.
There are some exciting alternatives to liquidation that preserve your Capital Gains Tax and Entrepreneurs’ Relief where you continue to contract. You would, however, need to discuss this with your Personal Accountant to explore how those alternatives work.
Achieving your aspirations
In conclusion, getting the most from your Limited Company is a combination of many factors:
- Your income needs
- The surplus income available
- Your personal circumstances
- Your desire to maximise take home pay
- Your plans for retirement
- Your family needs
- Your view on investment risk
Although there is never a simple solution or ‘one size fits all’ strategy, there is one act that can help you to get the most from your company. Appoint a reputable Independent Financial Adviser and get a specialist Personal Accountant who understands more than just IR35 and the simple salary and dividend solution.
How can Intouch Accounting help?
If you’re looking to make the most from contracting by getting the best from your Limited Company, then it’s time to speak to a specialist Personal Accountant that can help you do just that.
- As a client of Intouch Accounting you can relax in the knowledge that we’ll make sure your contractor business gets off to the right start and stays on the straight and narrow.
- At every step of the way you’ll receive expert accountancy advice from your specialist Personal Accountant dedicated to you, combined with our own contractor specific online accountancy software designed to make your life easier.
- We’ll remind you when you need to send us information. We’ll then process this on your behalf and, once you’ve confirmed it, send it to the taxman and Companies House on your behalf.
- And, for all of this, we charge you one all-inclusive monthly fixed fee! Speak to us today about how we can help you be a contracting success
If you have any specific questions or just need to chat through your options, you can get in touch with us for a no obligation discussion:
Call 01202 901 385