Extracting Profit From The Family Company

Extracting profit from a family company is an important issue directors are faced with. When extracting profit from a company it is usually desirable to do this in the most tax-efficient way possible and there are several options to consider. We discuss what the main options available are: Salary, dividends, pensions and paying family members and then look at which option is best for your business.

What to Consider

Before you decide which of the following options is best for you and your business. You may want to consider the following:

• Should you be retaining some of the profit in the business? If so, how much?
• What are the requirements of the members of the family that are working for the company? Both the short term and long-term plans of your family members can impact the decision and avenue that you choose.
• Which method will be most tax-efficient?

Salary vs Dividends

A salary is a business expense and is paid to employees (including directors) regardless of whether a company is in profit. Dividends, however, are paid to shareholders from the taxed company profits.

A common question is whether it is more efficient to extract profit through a salary or dividend payment or a combination of both. As corporate tax rates are generally falling and personal tax rates have risen over recent years, there is a trend for family companies to go down the dividend route when wanting to take money out of the business. And when combined with a salary, a tax-efficient profit extraction can be achieved.

Always ensure that the dividend payments you are distributing are legal. The Companies Act requires that dividends are only paid from distributable profits and reserves.

Paying a smaller salary, up to or just over NI limits, will preserve entitlement to state pensions and other benefits. It will also mean that now PAYE and little or no NI is paid.

A PAYE scheme will need to be set up and the director can then draw his net pay.

Paying a salary will also reduce corporation tax.

Be aware that dividends may not count towards your earnings in the eyes of many insurance companies and banks, who use your salary information to deem suitability for their products.

Pensions

A family company can make contributions to your pension scheme which can be a very efficient method of cash extraction. However, the pension benefits are liable to tax once they have been drawn. You also need to be aware that you may not be eligible to take out the cash from the pension scheme for several years.

A company usually receives a tax deduction against its profits for pension contributions. All contributions must be paid before the end of the accounting year before this tax deduction will be made. Employer pension contributions are tax and NIC free as long as the annual allowance for the director shareholder is not exceeded.

It is important to ensure that any pension contribution is proportional to the duties performed by that individual. Otherwise, the HMRC could challenge the contribution.

Paying Family Members

Paying family could also be considered looking at extracting profit. By paying members of the family that are on a lower tax band, you can get more income into the family pot. However, there are strict rules around this method that you must adhere to at all time. The remuneration an individual receives must reflect the work they perform for the company.

Retention of Profits

In reality, it is not always desirable to extract all of your company’s profits. By retaining some of the profit the value of your shares should increase over time. Bear this in mind when planning the long-term future of your family company.

What’s Next?
For many companies, a combination of the above methods may be the best option when it comes to extracting profit from your family business. There are pros and cons to each method and each business is unique so take time to understand the solutions and seek guidance. The team at Wright Vigar are here to help and can help explain which options of profit extraction are best for your family business. Give us a call on 0845 880 5678 or email us on website@wrightvigar.co.uk