Tax saving strategies for businesses
For most companies - their total tax bill is one of their largest business expenses. As we explain in our guide to the tax system for businesses, there are many different types of taxation that you're exposed, and tax planning must be approached holistically. Fortunately the government also does a lot to incentivise business growth by making available tax reliefs, so there opportunities to substantially reduce your tax bill with proper planning.
Tax optimal business structure
A key consideration in tax planning is to choose the most appropriate structure for your business. Limited Companies By operating as a limited company you separate the taxation of your business profits from your personal tax. From a tax perspective this means you are taxed both when you make profits (corporation tax) and when you extract money from the business (personal Income Tax and National Insurance Contributions), but in fact this can create significant tax planning opportunities, see our expert guide. Other tax advantages include: If you need additional funding via external investment (rather than borrowing), your investors may be entitled to tax breaks through the Venture Capital Trust (VCT), Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS). For more details on investments see our guide to business funding. Growing businesses looking to reinvest profits in the business generally pay a lower rate of tax if their business is incorporated. Companies reinvesting profits would only pay corporation tax at 19% (reducing to 17% by 2020 under current government plans). Most sole traders, partnerships or LLP's in this situation would pay income tax at 40% (41% in Scotland) or 45% (46% in Scotland). The additional tax paid can be a significant drag on investment in growth. Incorporated businesses making investment in innovative systems or processes may be eligible for Research and Development tax relief. The relief given is for more than the amount spent and is particularly generous towards small businesses. This relief isn't available to unincorporated businesses. Owners looking to sell incorporated businesses usually benefit from Entrepreneur's relief, which usually halves the amount of Capital Gains Tax due on selling your shares. Company pension schemes can provide greater benefits compared to those available to the self-employed. There are further tax planning benefits in how you motivate and retain key staff. For example the Enterprise Management Incentives scheme can be a very tax efficient way to give share options to staff. Other business structures By operating as a sole trader, partnership or LLP there is no separation between the profits of the business and your own personal tax. You pay income tax on your business profits in the period that they are earned. This eliminates most tax planning opportunities around profit extraction, and can also be a significant disadvantage when you're trying to leave profit in the business, as explained above. However: The tax system is simpler, and this can reduce professional fees and the potential for fines and penalties if you get things wrong. There can be tax savings for small owner managed businesses, due to differences in National Insurance (see below). When starting up, if you're likely to incur trading losses in your early years it can be better not to incorporate because you have more flexibility in offsetting your trading losses against other income (even against tax paid on employment in previous years). There can be cashflow advantages, since owner managers need to pay tax on any Director's salary by the 22nd of the following month, as opposed to bi-annual installments for other business structures. For businesses that hold assets that increase in value over time, including business property, it can be advantageous not to incorporate, as explained below. Decision making process Ultimately, choosing the most appropriate business structure is a complex topic with a lot of implications. Tax planning is only one aspect of your decision making. Whether you're a new startup or an existing business considering a change in structure, the starting point is your business planning and forecasting. You can find help in our guides to business planning and forecasting. With robust business plans and forecasts you have a detailed view on your future profitability, your expected rate of growth and the degree of commercial risks to your profits, which puts you in a great position to apply the above to your individual circumstances and make an informed decision.
Claiming all available business expenses and investment allowances
A key aspect of tax planning is to make sure that all allowable business expenditure has been offset against your taxable income and that you've claimed all the available tax allowancces on investments you've made in your business. Make sure you understand what expenditure and investment reliefs you could claim for so that nothing's overlooked and so that you can make informed decisions on the cost of investments after tax relief. This can be a complex issue, but you can find help in this free guide. Make sure you have the accounting systems and business processes in place so that you can include the expense in your tax calculation. The right systems help ensure that all relevant costs are captured in your accounts and that you've retained supporting evidence. You can find help in this free guide. Be mindful of the timing of expenditure - if you're planning expenditure close to your company year end then bringing forward expenditure could accelerate the tax relief by 12 months.
Ownership of assets likely to increase in value
If your business owns assets that are likely to increase in value (such as property) then there are specific considerations about capital gains tax payable when you come to sell them. For unincorporated businesses, there is no separation between business and personal assets. You are liable for capital gains tax on the gain you make when selling the asset. Companies pay tax on capital gains as part of their corporation tax. However, increases in asset value are also reflected in the value of the companies shares - meaning that when shares are sold a second capital gains tax charge is paid by the owner in their personal tax. This means that careful planning is required: When incorporating a business that already owns assets likely to increase in value, it's usually advantageous to leave those assets outside the new company. However, doing so has implications on the tax reliefs available on incorporation. For existing companies assets likely to increase in value should be purchased directly by the business owner(s), where this is possible, rather than inside the company. The assets are then leased to the business. This avoids the double tax charge, and brings further flexibility in how you extract profit from the business. Some assets can even be purchased within a personal pension scheme, bringing even more tax advantages.
Involving relatives in your business
Many owner managed businesses choose to involve their spouse, adult children or other family members in their business and this can form a legitimate part of tax efficient profit extraction. Employing family members Whatever your business structure, you can employ members of your family provided the salary and benefits you provide them are equivalent to what it would cost to employ an equivalent non family member to do the same work. The salary you pay is then an allowable business expense that reduces the tax you pay on business profits so can be a tax efficient way of transferring profits into your family, especially if they are paying Income Tax at a lower rate than you. Although consideration needs to be made of the overall tax cost, including employers national insurance contributions. Sharing business ownership Sharing business ownership is another alternative for tax efficiency across the family unit. If you operate through a limited company then you can allocate shares to family members. Dividend payments can then be used as a tax efficient way of extracting profit from the business, especially if other family members are paying Income Tax at a lower rate than you. We'd advice you seek professional advice first, since there are anti-avoidance rules that HMRC could apply. If you're unincorporated then putting the business into a partnership brings similar advantages. A partnership agreement withing your family allows flexibility in profit allocation. Keep in mind, however, that HMRC may challenge profit allocations and you would need to justify that they reflected different family members overall contribution to the business.
The cost of employing others in your business, including salary, benefits and the cost of employer National Insurance Contributions are an allowable business expense, reducing the tax paid on business profits. For incorporated businesses this also extends to your role as a Company Director. Good tax planning involves looking a the whole picture, not just the tax on business profits: Taking steps to minimise the employer National Insurance Contributions you make. Considering the Income Tax and National Insurance Contributions made by your employees. Although these aren't an expense for your business, taking steps to help your employee's keep more of what they earn has important benefits to staff retention and engagement. There are several options available: Increasing contributions to pension schemes where this makes sense for the individuals involved. Providing employees with childcare, a cycle to work scheme and other benefits that are exempt from Income Tax or National Insurance. For incorporated businesses - offering share incentive plans. These allow employees to buy shares in your company, saving both income tax and National Insurance. When this is a viable option, it can also be a cornerstone in your strategy for retaining and engaging key employees and managers. The Enterprise Management Incentive (EMI) scheme is usually the most generous of the various share schemes available to small businesses. See below for more details. For some small companies, in particular "solopreneurs", the differences in National Insurance Contributions for the business owner(s) may be so large that it may make sense to disincorporate and instead operate your business as a sole trader or partnership. Limiting Director's salaries for owner managers to below the National Insurance thresholds, or to use up any Employment Allowance that's still remaining after paying employees, is usually tax efficient. Instead make use of dividends or other means (such as interest on loans you've made to the company) to take cash out of the business.
Enterprise Management Incentive (EMI) scheme
This us usually the most generous of the various share incentive schemes that are available to small businesses. It allows employees to buy shares in the future at a price that's based on the market value of the business today. This means they benefit from any increase in value in the business and helps align their incentives with yours as business owner. Providing you meet the conditions of the scheme, there will be no Income Tax or National Insurance Contributions for the employee when the options are granted, held or exercised. What's more, when employees come to sell the shares they'll usually only pay Capital Gains Tax at the reduced rate of 10%. The company will be able to claim a Corporation Tax deduction when the shares are exercised, calculated as the market value of the shares on exercise less the amount paid by the employee.
Choice of Accounting Date
For an unincorporated business, the choice of accounting date can impact the timing of your tax payments. For a growing business, an accounting year end earlier in the tax year (i.e. closer to 6th April) means that your tax bill increases more slowly as your profits increase. Be warned that the converse is also true, and your tax bill takes longer to reduce if profits dip, you're scaling back or looking to retire. The rules around how profits are taxed in the early years of a business means that some profits are taxed twice in your first years of trading. These are known as overlap profits. You get the excess tax back when you stop trading or change your accounting date. If you expect a permanent fall in profitability then changing your accounting date to 5th April can be an advantage by triggering the repayment of the tax on your "overlap profits".