The Chancellor’s recent mini-Budget and subsequent U – turns threw a number of spanners into the works as far as profit extraction strategies are concerned. Initial revisions to profit extraction strategies in the light of the mini-Budget announcements now need to be revised.

Rates

For 2022/23, the dividend allowance is £2,000. Where dividends are not sheltered by the dividend allowance or any unused personal allowance, they are taxed at the dividend ordinary rate of 8.25% where they fall in the basic rate band, at the dividend upper rate of 33.75% where they fall in the higher rate band and at 39.35% where they fall in the additional rate band.

The rates were increased from 6 April 2022 by 1.25% as part of a package of measures to raise funds for health and adult social care with the introduction of a dedicated Health and Social Care Levy.  The Health and Social Care Levy has since been scrapped. It was announced at the time of the mini-Budget that the increased would be reversed from 6 April 2022. However, new Chancellor Jeremy Hunt subsequently announced that this will now not happen and dividend tax rates will remain at their 2022/23 levels.  The basic rate of income tax was due to fall from 6 April 2023 from 20% to 19%. This cut has now been delayed and the basic rate will remain at 20%.

Extracting profits

If profits from a personal or family company are to be used for personal use, they need to be extracted from the company. There are various ways in which this can be done, but from a tax perspective, the goal is to do so in a way that minimises the total tax and National Insurance payable.

A popular tax efficient strategy is to take a small salary and to extract further profits as dividends. The optimal salary depends on whether the National Insurance employment allowance is available. If it is, as may be the case for a family company, the optimal salary for 2022/23 (assuming the personal allowance has not been used elsewhere) is equal to the personal allowance of £12,570. Personal companies where the sole employee is also a director do not benefit from the employment allowance. Where the employment allowance is not available, the optimal salary for 2022/23 is equal to the annual primary National Insurance threshold of £11,908.

The changes announced in the mini-Budget and the subsequent U-turns do not change the optimal salary for 2022/23.

Taking dividends

Once the optimal salary has been paid, it is more tax efficient to take any further  yet)profits needed outside the company as dividends. Dividends are paid from post-tax profits and have already suffered corporation tax of 19%. The reinstatement of the proposed corporation tax reforms will mean that the funds from which dividends have paid may have suffered a rate of tax of more than 19% from 1 April 2023. This will be the case where profits exceed the lower profits limit, set at £50,000 for a stand-alone company.

For 2022/23, dividends should still be extracted (assuming sufficient retained profits are available) to use up the dividend allowance and any remaining personal allowance of the director and, in a family company scenario, any family members who are shareholders. Once the allowances have been used up, taking any further dividends will trigger a tax liability on those dividends. If the funds are not needed outside the company, it may be preferable not to pay a dividend to avoid the associated tax charge, perhaps delaying the payment of the dividend until it can be sheltered by a future year’s dividend or personal allowance.

Where further dividends are needed, the aim is to pay as little tax as possible. In a family company scenario, this may mean using the basic rate band of family members before paying dividends to the director where they would be taxable at a higher rate. As dividends must be paid in proportion to shareholdings, the tailoring of dividends to achieve this is only possible with an alphabet share structure whereby each family member has their own class of shares.

There is no substitute for crunching the numbers.

If you operate your business as a personal or family company, you will need to extract some or all of the profits if you wish to use them personally. When it comes to tax, not all profit extraction methods are equal. While personal circumstances will dictate the most efficient way for you to extract profits, the following five extraction methods should be considered as part of a tax-efficient profit extraction strategy.

Method 1: salary

Paying a small salary can be tax-efficient where the recipient has not used their personal allowance elsewhere. Paying a salary that is at least equal to the lower earnings limit for National Insurance purposes (£6,396 for 2022/23), will ensure that the tax year is a qualifying year for state pension purposes; this can be useful where the recipient does not already have the 35 qualifying years needed for a full state pension.

For 2022/23, the optimal salary will depend on whether the National Insurance Employment Allowance is available to shelter any employer’s National Insurance on the salary. Assuming the personal allowance remains available in full, the optimal salary where the Employment Allowance is not available (as is the case in a personal company where the sole employee is also a director), is one equal to the primary threshold for 2022/23 of £11,908. If the Employment Allowance is available (or one the higher secondary Class 1 National Insurance thresholds applies), the optimal salary is one equal to the personal allowance, set at £12,570 for 2022/23.

Method 2: dividends

Dividends are paid from post-tax profits, and the profits from which they are paid have already suffered corporation tax. As all taxpayers benefit from a dividend allowance (set at £2,000 for 2022/23), where this remains available, paying a dividend up to this amount allows profits to be extracted free of any further tax. Once the optimal salary has been paid and the dividend allowance has been used, if further profits are needed outside the company, it is generally preferable to take dividends rather than additional salary as the dividend tax rates are lower and there is no National Insurance to pay on dividends.

Remember, dividends must be paid in proportion to shareholdings. However, using an alphabet share structure preserves flexibility. Remember, dividends can only be paid if you have sufficient retained profits from which to pay them.

Method 3: rent

Many personal or family companies are based at home. The company can rent a room from the director and pay rent for the privilege. This can be tax efficient, as the company will benefit from a deduction for the rent paid when calculating its profits for corporation tax purposes. While the rent is taxable in the hands of the director, if the director does not have other rental income, he or she may be able to benefit from the property income allowance to receive £1,000 of rent tax-free. Paying rent has the added advantage that there is no National Insurance to pay.

Method 4: pension contributions

The company can also make pension contributions on behalf of the director (and/or his or her family). The company will usually be able to deduct the pension contributions in full when calculating its profits. Providing the contributions do not exceed the available annual allowance or take total tax relieved contributions above the level of the lifetime allowance, there will be no tax charges on the recipient.

Method 5: benefits-in-kind

It can be particularly tax-efficient to provide directors and family employees with exempt benefits in kind, such as a mobile phone or workplace parking, as the recipient will enjoy the benefit tax-free, while the company can deduct the cost in calculating its taxable profit. Where an exemption applies, there is no Class 1A National Insurance for the company, and most benefits in kind are free of employee National Insurance.

Benefits-in-kind can still be tax efficient even if a tax charge applies; for example, it may be beneficial for the employee to have an electric company car rather than be given more salary from which to fund the car. Providing a benefit rather than additional salary will also save employee’s National Insurance as most benefits-in-kind are liable to Class 1A (employer-only) rather than Class 1.

You must register for VAT if your VAT taxable turnover for the last 12 months exceeded the VAT registration threshold of £85,000, or if you expect your turnover in the next 30 days to exceed this amount. However, while you are not obliged to register for VAT if your turnover is below this level, you can choose to do so voluntarily.

Is this beneficial?

Need to charge VAT

If you are VAT registered, you will need to charge VAT on taxable supplies that you make. Unless you make zero-rated supplies (for example, zero-rated foods), this will make your products more expensive to the purchaser. If predominantly you supply to VAT-registered businesses, this may not be an issue as they will be able to recover the VAT charged. However, if you supply to individuals, charging VAT may make you less competitive against businesses that are not VAT-registered. If you supply standard-rated goods, you will need to add on 20%.

Ability to recover input VAT

One of the main advantages of registering for VAT voluntarily is that you will be able to recover the VAT associated with making taxable supplies (including those that are zero-rated). However, if you make exempt supplies, you cannot recover the associated input tax.

Businesses that make zero-rated supplies only or mainly should consider registering for VAT voluntarily if their turnover is below the VAT registration threshold as they will be able to recover any associated input tax, but the imposition of VAT at the zero rate will not make their supplies more expensive.

Compliance obligations

Registering for VAT comes with an associated compliance burden. All VAT-registered traders are now within Making Tax Digital (MTD) for VAT. Consequently, they must maintain digital records and file VAT returns using software that is compatible with MTD for VAT. This will involve both time and costs, which may outweigh any VAT recovered.

Do the sums

To assess whether it is worthwhile registering for VAT voluntarily, there is no substitute for doing the sums to see whether what you could potentially recover is worthwhile.

Although spouses and civil partners are taxed independently, there are some tax breaks available. One of these is the ability for spouses and civil partners to transfer assets between them at a value that for capital gains tax gives rise to neither a gain nor a loss.

This can be very useful from a tax planning perspective.

No gain/no loss rule

The no gain/no loss rule essentially means that where an asset is transferred from one spouse to another, the value of that asset is equal to the transferor’s base cost. This is the case regardless of whether there is any actual consideration and the amount of that consideration. Unlike other transfers between connected persons, the market value rule does not apply.

The effect of this rule is that any gain that has accrued while the transferor has owned the asset is passed to the transferee and is not chargeable on the transferor. The gain does not crystallise until the asset is disposed of outside the marriage or civil partnership.

Example

Peter purchased a painting in 2013 for £6,500. In 2018, he transferred the painting to his wife Pauline. At that time, the painting was worth £9,000. Pauline sells the painting at auction in August 2022 for £12,000.

When Peter transfers the painting to Pauline in 2018, it is deemed to be transferred at a value of £6,500. This is the Peter’s base cost and the value that gives rise to neither a gain nor a loss. Pauline assumes Peter’s base cost of £6,500. There is no capital gains tax to pay on the increase in value of £2,500 during Peter’s period of ownership.

When Pauline sells the painting in 2022, the full gain of £5,500 is chargeable (£12,000 – £5,000). Pauline is liable for the full gain, not just the increase in value since she acquired the painting.

Pauline realises no other gains in the tax year, and the gain is sheltered by her annual exempt amount.

If the painting had fallen in value to below £6,500, Pauline would have the benefit of the loss.

Tax planning opportunities

This rule opens up a number of tax planning opportunities.

1. Access unused annual exempt amounts

Transferring an asset or a share in an asset prior to disposal can access a spouse or civil partner’s unused annual exempt amount. The annual exempt amount for 2022/23 is £12,300. Using this strategy can save the couple up to £2,460 in tax (£12,300 @ 20%), or £3,444 for residential property gains (£12,300 @ 28%).

• Make use of a lower tax band

Where a gain cannot be fully sheltered by available annual exempt amounts, if the spouses/civil partners have different rates of tax, the no gain/no loss rule can be used to share the chargeable gain so that it is taxed at the lowest rate of tax. For example, by taking this route, it may be possible to reduce the tax paid on some or all of the gain from 20% to 10%, or for residential property gains, from 28% to 18%.

• Change income allocation

Income from an asset owned jointly by spouses and civil partners is taxed 50:50 regardless of the actual ownership shares, unless a Form 17 election is made. However, to ensure that income is taxed at the lowest possible marginal rates, the no gain/no loss rules can be used to change the underlying ownership to the desired shares. A Form 17 election can then be made so the individuals are taxed on the income by reference to those shares.

• Access business asset disposal relief

Business asset disposal relief reduces the rate of capital gains tax to 10% on qualifying gains up to the £1 million lifetime limit. Each spouse or civil partner has their own limit. To access each partner’s limit, assets or shares can be transferred from one spouse or civil partner to the other prior to the disposal of the business or its shares. However, remember the conditions must be met for two years prior to the disposal meaning it is necessary to plan ahead.

Where a business is operated as a family company, it is necessary to extract the profits from the company in order to use them outside the company for personal use, such as to meet living expenses. Extracting profits may trigger further tax and National Insurance liabilities, and when formulating a strategy, it is advisable to extract profits in as tax-efficient manner as possible. What this will look like will, to a certain extent, depend on individual circumstances. However, that said, a popular and tax-efficient profit extraction strategy is to take a small salary and extract further profits as dividends.

For 2022/23, assuming the personal allowance is not used elsewhere, the optimal salary is equal to the primary threshold of £11,908 where the employment allowance is not available and equal to the personal allowance of £12,570 where the employment allowance is available to shelter employer’s National Insurance.

Dividend allowance

The dividend allowance is not an allowance as such. Rather, it is a zero-rate band. Where dividends fall within this band, they are taxed at a zero rate so that they are free of tax in the hands of the shareholder. The dividend allowance is available to all taxpayers, regardless of their marginal rate of tax. For 2022/23, the dividend allowance is set at £2,000. Dividends are taxed as the top slice of income and the dividend allowance uses up part of the tax band in which it falls.

Dividend policy

In a family company scenario, the availability of the dividend allowance can be used to drive dividend policy. However, when paying dividends to utilise available dividend allowances, it should be remembered that dividends can only be paid out of retained profits and must be paid in accordance with shareholdings. This can be overcome by the use of an alphabet share structure by which each shareholder has their own Class of shares, e.g. A ordinary shares, B ordinary shares, C ordinary shares, etc, and which provides flexibility to tailor dividends to individual circumstances.

Dividends are paid from post-tax profits and have already suffered corporation tax.

To prevent dividend allowances being wasted and optimise the opportunity to extract profits without triggering further tax liabilities, in a family company scenario it makes sense to make family members shareholders, even if they have other income and do not work in the company. The benefits are illustrated by the following case study.

Case study

Dave is the director of a family company DJ Ltd. His wife and two grown-up daughters are shareholders in the company. Dave has 100 A ordinary shares, his wife has 100 B ordinary shares and his daughters, Delia and Diane, have, respectively, 100 C ordinary shared and 100 B ordinary shares.

The company has made a post-tax profit of £20,000 that Dave wishes to extract. Dave has received a salary of £12,570 from the company, as does his wife, Debbie. Both Dave and Debbie have income from property and pay tax at the higher rate.

If a dividend of £200 per share is declared for A class shares, Dave will receive a dividend of £20,000. After deducting the dividend allowance of £2,000, the balance of £18,000 is taxed at 33.75% — a tax bill of £6,075.

If, instead, the company declares a dividend of £1,400 per share for A class shareholders and a dividend of £20 per share for B, C and D Class shareholders, Dave will receive a dividend of £14,000 and his wife and daughters will each receive a dividend of £2,000.

In this scenario, Dave will pay tax of £4,050 on his dividend (33.75% (£14,000 – £2,000)). However, his wife and daughters will receive their dividends tax-free as they are sheltered by their dividend allowances.

By using an alphabet share structure and taking advantage of family members’ dividend allowances, the combined tax bill has been reduced by £2,025.

If his daughters have not fully utilised their basic rate bands, changing the dividend mix to make use of this can produce further savings.

Employers must act as a tax collector for HMRC, deducting tax, National Insurance and, if applicable, student loan deductions, from their employees’ pay and pay these over to HMRC with their employer’s National Insurance contributions. The payments must reach HMRC by 22^nd of the following tax month where payment is made electronically, and by the earlier date of 19^th of the following tax month where payment is made by cheque.

As penalties are charged if the payments are made late for more than one month in the tax year, it is important that these deadlines are not missed. A new recurring direct debit facility may help employers to meet the payment deadlines and avoid penalties.

Payment options

There are currently a range of payment options available to employers to pay their PAYE. Payment methods include online banking, using a debit card or a corporate credit card or at a bank or building society. Cheques can also be sent in the post, but an earlier payment deadline applies.

It has been possible to pay by direct debit, but only as a one off. However, as from 19 September 2022, employers are now able to set up a recurring direct debit to pay their PAYE.

Payment via variable direct debit

Employers wishing to pay by direct debit each month will need to set this up through their business tax account and the Employer’s PAYE Online service.

A new option will be added to the employers’ liabilities and payments screens, which will feature the option to ‘set up a direct debit’. This will provide HMRC with authorisation to collect the PAYE and NIC that they owe, as shown on their RTI payroll submission, direct from the employer’s bank account.

Once the employer has set up a recurring direct debit facility, the link will change to ‘Manage your direct debit’. This will allow the employer to view, change or cancel their direct debit online.

It should be noted that only the employer can set up, amend and cancel the direct debit; this is not something that can be done by their agent on their behalf.

Inheritance tax is often described as a voluntary tax. While most of us do not know in advance when we are going to die, there are steps that you can take to reduce the amount of inheritance tax on your estate. Here are five suggestions.

1. Leave everything to your spouse or civil partner

The inter-spouse exemption means that there is no inheritance tax to pay on anything that you leave to your spouse or civil partner. On their death, their estate can claim the unused portion of your nil rate band and your residence nil rate band, meaning that these are not wasted. The allowances allow a married couple or civil partners to, between them, leave £1 million free of inheritance tax.

Alternatively, you can leave assets to the value of your nil rate band, and a main residence or share in a main residence to your children or direct descendants, and anything in excess of this to your spouse or civil partner. This too will ensure that there is no inheritance tax to pay on your estate.

2. Give away cash and assets early

Gifts made more than seven years before your death fall out of charge for inheritance tax purposes. Also, taper relief means that the rate of tax payable  on assets gifted made more than three years before your death is reduced on a sliding scale. Lifetime gifts are known as potentially exempt transfers and remain exempt if you survive for at least seven years after making the gift. However, if you do die within seven years, lifetime gifts come into charge. This may give rise to an unintended problem in that the nil rate band is applied chronologically, meaning that it may shelter a lifetime gift which would, if taxable, benefit from generous taper relief, rather than a death bequest which is chargeable at 40%.

The earlier gifts are made, the greater the likelihood that they will fall out of charge.

3. Make gifts out of income

An inheritance tax exemption means that it is possible to make lifetime gifts which are not treated as potentially exempt transfers by making them out of your income. To benefit from the exemption, the gift must be made as part of the normal expenditure from the income of the donor and, after making the gift, the donor must be able to maintain their standard of living. This exemption could be used, for example, to pay for your grandchildren’s school fees or your child’s rent  or to set up a regular standing order to help meet your children’s living costs.

4. Use the annual and gifts exemptions

There are a number of specific inheritance tax exemptions that allow you to make small gifts that fall outside the scope of inheritance tax. These exemptions can be used in addition to the gifts from income exemption outlined above. Further, they apply if the gifts are made from capital.

The annual exemption allows you to give away £3,000 of gifts each year. You can use the allowance to make a single gift to one person, or several gifts totalling not more than £3,000. If you do not use all of the exemption for a tax year, you can carry the unused portion forward to the following tax year. However, if it is not used by the end of that tax year, it is lost.

The small gifts allowance allows you to make as many gifts as possible of up to £250 per person each tax year. However, the recipient cannot benefit from more than one allowance (so you cannot give £3,250 to one person using the annual allowance and the small gift allowance). You do not need to count birthday and Christmas gifts, which are exempt.

You can also make tax free gifts on the occasion of a wedding or civil partnership. The exempt amount depends on your relationship to the recipient – £5,000 for a child, £2,500 for a grandchild or great-grandchild and £1,000 for any other person.

5. Make a charitable bequest

Your estate can benefit from a reduced rate of inheritance tax of 36% if you leave at least 10% of your estate to charity. Gifts to charities are themselves exempt from inheritance tax.

If you are an employer, it is beneficial for both you and your employees if your workforce is healthy. Consequently, you may want to offer benefits to help employees spot any issues early and get back to full health.

While the provision of private medical insurance (other than for employees working overseas) is a taxable benefit, the tax system contains a number of health-related exemptions.

Health screening and medical check-ups

Employees can be provided with one health-screening and one medical check-up each tax year without triggering a tax charge under the benefit-in-kind legislation. For these purposes, a health screening assessment is an assessment to identify an employer who may be at a particular risk of ill-health, whereas a medical check-up is a physical examination of the employee by a health professional for the sole purpose of determining the employee’s state of health.

The provision of additional health screenings and/or medical check-ups in the same tax year are taxable and must be notified to HMRC on the employee’s P11D.

Recommended medical treatment

While there is no general tax exemption for employer-funded medical treatment, there is a dedicated exemption for medical treatment that meets the definition of ‘recommended medical treatment’ which is provided or paid for by the employer. This is treatment recommended by a health professional as part of occupational health services provided to the employee to help the employee retain employment or is provided to assist the employee in returning to work after a period of absence due to injury or ill health (such as physiotherapy to help the employee return to work after a back injury).

The exemption is capped at £500 per tax year. Where the cost of the treatment is more than this, the employee is taxed on the excess over £500.

Overseas medical treatment and insurance

A tax liability arises in respect of the provision of medical treatment, other than recommended medical treatment, provided to UK-based employees. However, there is no tax liability where an employer provides medical treatment outside the UK and the need for the treatment arose while the employee was overseas for the purpose of performing the duties of the employment. The exemption extends to the provision of insurance against the cost of providing such treatment.

Eye tests and glasses

Where an employer is required by regulations made under the Health and Safety at Work Act 1974 to provide an employee with an eye test, no tax liability arises in respect of that test. If the test shows glasses and contact lenses are needed, the provision of these are also tax-free. However, the exemption is conditional on the access to tests and the provision of corrective appliances to those who need them is available to all employees to whom such tests must be provided.

Inflation is at a ten-year high and the ensuing cost of living crisis means that many people may be struggling to pay the tax that they owe. If this is you, what can you do about it?

While it may be tempting to bury your head in the sand and hope that the bill will magically disappear, this is a really bad idea. Ignoring the problem will in this instance make it worse; HMRC will eventually want their money and have a range of tools available to them to help them achieve this.

It is far better to take control of the situation. Rather than having to pay everything in one go, you may be able to pay in manageable instalments.

Set up an online plan

If you are struggling to pay a self-assessment tax bill you may be able to set up an instalment plan (known as a Time to Pay arrangement) online. To do this, you will need to log in to your Government Gateway account.

A Time to Pay agreement can be set up online if:

• you have filed your latest tax return;
• you owe less than £30,000;
• you are within 60 days of the payment deadline; and
• you plan to pay your debt off within the next 12 months or less.

Call HMRC

If you are not able to set up an instalment payment plan online, for example, because you owe tax of more than £30,000 or need longer to pay, you can call HMRC’s Self-Assessment helpline to see if you are able to agree one over the phone. The Self-Assessment Payment Helpline number is 0300 200 3822. The helpline is open from 8a.m. to 6p.m. from Monday to Friday.

Information required

You will need certain information to set up a Time to Pay arrangement, including:

• your unique tax reference (UTR) number;
• your bank account details; and
• details of any payments you have missed.

HMRC will ask you whether you can pay in full (if you can, they will expect that you do), how much you can repay each month, if you owe other taxes, how much you earn, what your monthly outgoings are and what savings and investments you have. If you have assets or savings, HMRC expect that you will use these to pay any tax that you owe.

Stick to the plan

Once you have agreed a Time to Pay arrangement, it is important that you make the payments in accordance with the plan, If you miss a payment HMRC will normally contact you to find out why, and where possible will restore the plan. However, if you continue to fault, HMRC will seek to collect the debt in full.

If further tax liabilities arise that you cannot pay, it may be possible to amend the plan to include these.

Bad debts are a fact of business life and most businesses will suffer a bad debt from time to time. This may be because the customer goes out of business after the work has been done or the goods have been supplied, or runs into financial difficulty resulting in them defaulting on the debt. Unfortunately, sometimes the customer may just not pay and refuse all attempts to recover it.

While there are actions that the business can take to recover the debt (such as making a claim using the Money Claim Online service), there is no guarantee that these will work, and the business may simply have to accept that the debt has gone bad.

Having suffered a bad debt, it would be adding insult to injury if the business had to pay tax on income that had not actually received. Fortunately, the tax system offers some relief for bad debts.

The way in which relief is given depends on whether the accounts are prepared under the cash basis or the accruals basis.

Cash basis

One of the advantages of the cash basis is that it provides automatic relief for bad debts. Under the cash basis, income is not recognised until it is received, so if an invoice is not paid, it is not taken into account when calculating taxable profits. Consequently, there is no need for special rules to deal with bad debts.

Traders with cash basis receipts of £150,000 or less can elect to use the cash basis. It is the default basis for landlords with rental cash basis receipts of £150,000 or less, and landlords not wishing to use the cash basis must elect for the accruals basis to apply. Companies cannot use the cash basis to prepare their accounts.

Accruals basis

Under the accruals basis, income must be recognised when earned. This means that if work is undertaken, the associated income is taken into account when the work is done not when the invoice is paid. Consequently, the invoiced amount will be reflected in the calculation of taxable profit, regardless of whether it has been paid. The amount owing will show in the balance sheet as a debtor of the business.

Normally, a deduction is not allowed for a debt owed to a business in computing the taxable profit. However, an exception is made for a bad debt and for a doubtful debt to the extent that it is estimated to be bad. This will be the total amount of the debt less any amount that the business may reasonably expect to receive.

Where a debt is bad or doubtful, a deduction can be made in the period in which the debt became bad or doubtful. This may not necessarily be the same period as when the income is taxed if at that point it was expected that the debt would be paid.

Example

ABC Ltd prepares accounts to 31 March each year. As a company, it prepares accounts using the accruals basis.

On 21 March 2022 it invoices a customer for £3,000.

The invoice is taken into account in calculating the taxable profit for the year to 31 March 2022.

In July 2022, the customer went into liquidation without paying the debt. Recovery looks very unlikely.

Tax relief is given in the form of a deduction of £3,000 when calculating the profit for the year to 31 March 2023 as this is the period in which the debt went bad.