retain profits questions ltd. company

[BobFisher]

Hi there,

I run a small ltd company and am looking to retain the profits for a
few years in the company to build up the value and cash in the company which I will then sell. I will only pay myself a small amount.

My questions are:

1. Am I only taxed once on money kept in the company

and 2.

How does doing this effect things like tax credits?

Thanks, Bob

[elainec100@cheapaccounting]

The company is taxed on profit.

Profit = Income - costs

[BobFisher]

Thanks Elaine - I understand that income minus costs = profit.

My questions is, if I leave the money in the company, am I taxed on it in future years? and how does doing so effect things like tax credits?

Thanks,
Bob

[JohnGreer]

Hi Bob,

Hope you are well

It is a common question for company owners - so here is some background.

The limited company is, as I'm sure you know, a separate legal entity, so it legally exists in its own right.

It pays corporation tax on its profits and as Elaine says, the profit of the company is its income less expenditure.

Corporation tax is currently 21% so if your company had made say £50,000 profit it would pay £50,000 x 21% = £10,500.

That would leave £50,000 - £10,500 = £39,500 in the company. You say that you intend to leave the post tax profit in the company for a few years, so it would only be when you are taking profit out of the company that you may pay tax.

You can extract profit in a number of ways, however the two most common ways are salary (as a director) and dividends (as a shareholder).

Director salary is no different to any other job so you would pay PAYE and National Insurance, however it is common practice to take only about £6,000 in salary as there is effectively no tax or NI at that level of salary.

Dividend tax is a little more complicated. You need to be aware of your personal income tax rates and the bands for basic rate and higher rate tax. Essentially, if your dividend income falls within your basic rate band then there will be no tax to pay on the dividend income. If the dividend falls into the higher rate band, then you will have to pay 25% of the dividend drawn.

So, if you take a small salary and can keep your dividends within the basic rate band, you will not have any personal tax to pay on the sums taken out of your company.

Another commonly found setup is to give half of the shares in the company to your spouse so that they can receive dividends within their basic rate band as well.

This is currently a notorious area of interest for the tax office. There are income shifting rules and settlements legislation, all of which are designed to prevent you from moving what the tax man sees as your income to your spouse. It can get horribly complex and needless to say some proper advice is essential.

In terms of tax credits, if you are only taking a small salary from the company then it is likely that you will qualify for tax credits as well as your income for a tax year will relatively low.

I hope the above has answered your questions, however if any element needs clarification please just ask

Best wishes

John

[elainec100@cheapaccounting]

Thanks Elaine - I understand that income minus costs = profit.

My questions is, if I leave the money in the company, am I taxed on it in future years? and how does doing so effect things like tax credits?

Thanks,
Bob

You are not taxed on it in future year - you pay the tax when you make the profit.

As regards tax credits these are based on your income as an individual nto the limited company income.

[BobFisher]

Thank you John for your excellent advice

[Philip Hoyle]

For tax credits, you have to be paid the national minimum wage, so you need to at least pay NMW for the requisite number of hours for which you are claiming tax credits, so there will be tax and NIC on that wage.~

As you probably know, in your capacity as a director, you don't have to pay yourself NMW, but the rule is different for tax credits where you do!

So if you want to claim tax credits, then NMW is a requirement.

[BobFisher]

Thank you Philip and Elaine for the answers... and an extra special thanks to John for such a comprehensive answer.

[John Mansley]

It might be worth paying dividends up to the basic rate band and then loaning the cash back to the company. You won't suffer any tax on such dividends (assuming no other income) or when you repay the loan.

This could be a useful strategy if you are planning on drawing more than basic rate dividends in future years. Eg, you make £30k of profit in both of years 1 and 2. If you declare a dividend of £60k after year 2 you'll pay some higher rate tax on the dividend. If you paid £30k dividend after year 1 and repaid it back into the company as a director's loan, then you can draw the full £60k after year 2 with no tax implications.

[Wild Goose]

For tax credits, you have to be paid the national minimum wage, so you need to at least pay NMW for the requisite number of hours for which you are claiming tax credits, so there will be tax and NIC on that wage.~

As you probably know, in your capacity as a director, you don't have to pay yourself NMW, but the rule is different for tax credits where you do!

So if you want to claim tax credits, then NMW is a requirement.

Unless you also happen to be registered as self-employed - say as an e-bay trader for example - in addition to being employed as a director of your company. That way you need pay yourself only the optimum £470 per month as an employee/director, thereby avoiding incurring NI and tax and avoiding NMW issues, whilst making up the requisite 30 hours pw working hours via your self-employment.

It might be worth paying dividends up to the basic rate band and then loaning the cash back to the company. You won't suffer any tax on such dividends (assuming no other income) or when you repay the loan.

This could be a useful strategy if you are planning on drawing more than basic rate dividends in future years. Eg, you make £30k of profit in both of years 1 and 2. If you declare a dividend of £60k after year 2 you'll pay some higher rate tax on the dividend. If you paid £30k dividend after year 1 and repaid it back into the company as a director's loan, then you can draw the full £60k after year 2 with no tax implications.

Good tax strategy. The downside is the divs will count as income for tax credit purposes.

It is possible to work around that by taking divs every second year, given that a £25k uplift in income is disregarded for tax credit purposes. So Yr 1 income of £4.5k, yr 2 £4.5k + say £24k divs, yr 3 back to £4.5k and so on. The point is that the Yr 2 tax credit claim would be based upon Yr 1 income of £4.5k, not on the actual £28.5k income, because the Yr 2 £24k uplift is less than £25k.