Why extracting money from your property company may not be necessaryFirst Published: April 2013 | Available in: Property Articles Your Property Network
Some property investors and entrepreneurs who operate via a limited company seem to be overly-concerned with how to immediately extract profits from their company. This article looks at how company owners can get maximum benefit from their company profits – whether extracted or retained.
First things first – extract what you can.
The standard way for a company owner to extract profits from a company is to take a small ‘personal allowance’ salary of around £8k (2012-13), plus a dividend of around £35k.
This set-up makes sense because the salary is covered by the owner’s Personal Allowance (hence no income tax to pay), but the salary is a tax-deductible expense for the company.
The dividend payable is paid after the company has paid its tax and so dividends up to the Higher Rate tax threshold (£42,475) are tax-free for shareholders.
A husband and wife can therefore earn around £6,500 per month – or £78,000 per tax year – from their company per tax year. Hopefully that is enough for most people, given that there is no tax or Ni deducted from this amount.
This is the key tax benefit for company owners:
National Insurance is not payable on the ‘small-salary-plus-dividend’ combination.
Company owners can avoid Higher Rate (40-45%) income tax by restricting their total drawings from the company (salary = dividend) to £42,475 per person
Why can’t I just extract all the profits that my company makes?
The simple answer is that you can – BUT, dividends paid above the Higher Rate tax threshold of £42,475 are subject to a net 25% tax charge.
This would mean, for example, a £10,000 dividend taken from a company for a person already paying Higher Rate income tax would incur a £2,500 tax bill. Given that this is on top of the £2,500 corporation tax paid by the company to generate post-tax profit of £10,000, this is obviously a significant disincentive to extract more dividends once the Higher Rate tax bracket has been reached.
So what do I do with the funds left in my company if I can’t extract them tax-efficiently?
The first point to make is that the funds are still yours – they are just sat in a company bank account. So what can be done with the monies?
Extract all expenses possible.
Don’t forget that any expenses incurred by the owners / employees on company business – e.g. travel, computer and office equipment, home office costs etc. – can be reimbursed tax-free to the company. This also includes business mileage @45p per mile (first 10,000 miles, 25ppm after this), where the company ‘hires’ the owner’s car for business use.
A key benefit of operating a company is the option to claim many more costs – and be paid for these by the company – than a PAYE-employed person can, for example.
Remember – company owners pay tax on what is left AFTER expenses – whereas PAYE-employed people pay their tax FIRST, and then pay their expenses with taxed money.
Can your property company loan funds to another company you own?
It’s quite common for an investor to have a ‘day job’ company that may require funds to expand. Why not lend the funds in the property company to the ‘day job’ company? There are no taxes due by extracting the funds and interest may be charged at a commercial rate if required – or with no interest – your own cheap bank!
Loan funds to other investors.
Cash funds within a company can be made to work harder than simply lying in a bank account. Many company owners with spare cash lend these monies out to other investors – often for a significant return. With the borrower typically paying legal costs, providing 1st or good 2nd charge security, a return of 1%+ per month, and entry / exit fees, this can be a lucrative use of cash ‘trapped’ in a company but beware, there are many property sharks out there!
Invest the funds in a property.
Most property investors are keen to invest ‘excess’ cash into property. Why not do invest in property with funds held WITHIN the property company? This means that no tax is payable when funds are extracted – since funds are not being extracted – so saving 25% tax for Higher Rate taxpayers. Rental profits are retained within the company and so taxed just at the corporation tax rate of 20%. Limited companies can get mortgages – admittedly with lower LTVs than personal mortgages – but it’s quite common for older / more advanced investors to have their
‘earlier’ properties owned personally and ‘later’ properties owned in their company.
Invest in other assets.
Companies can invest funds in any type of asset or investment they choose – there are other investment options than property; shares, gold, silver, ‘Enterprise’ companies, gilts, bonds, wine, classic cars. Have to say this is not a route that many of our clients take though!
Use the funds temporarily via a ‘directors loan’.
Directors can borrow from their company via a ‘directors loan’ – this is taxed if not repaid within 9 months of the company’s year-end, but allows a short-medium term loan which is often perfect for developers and those that buy BMV / refurb / re-finance.
A commercial rate of interest (currently 4%) must be paid on the funds to the company to avoid a tax charge on the loan ‘benefit’, but of course this comes back to the director as s/he owns the company.
This can be a handy and cheap bridging facility which ultimately can mean more deals and profits – since ‘cash is king’
And finally …
The final option is to extract the funds but at a later date when the owner is no longer a Higher Rate taxpayer. Use the company as a low-tax investment vehicle and allow the funds to roll up over the years to be extracted at a later date once the owner ‘retires’ and income reduces.
Or, for PAYE-employed people looking to build up a fund tax-efficiently while still employed, the rolled-up funds can be drawn down once the investor ceases employment – providing a handy income while the new property business becomes established.