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You are the sole director in a company that undertakes some R&D. The annual profit is estimated at £140,000 for the year ended 31 March 2016 before taking into account the director’s remuneration.
You might think that the most tax-efficient remuneration package is £10,600 for 2015/16 to cover the personal allowance and then net dividends of £28,606 to take the director up to the basic rate band. You also need to consider whether the company can make an R&D relief claim and, if it can, how this might affect your decision.
Salary vs Dividends
If the director takes a typical remuneration package, then the net tax and NI savings over taking a salary of £39,206 would be £5,265, assuming the £2,000 employment allowance is available. This saving is made because dividends received within the basic rate band attract no further income tax plus no NI for the director or the company. This more than outweighs the additional corporation tax suffered on profits retained for dividends.
Taking R&D relief into account
From 1 April 2015 the R&D tax credit for SMEs increased from 225% to 230%. There is no R&D uplift on dividends received – only on salary. This means that paying a £39,206 salary would actually result in a saving over taking a small salary and dividends of £1,208.
What about a larger salary? In fact, if the client wanted to take out more than the basic rate band, then the salary may become even more tax efficient. A £70,000 salary would result in net tax/NI due of £1,366 after the R&D relief (assuming there was sufficient profit to offset the CT relief), whereas a salary of £10,600 and net dividends of £59,400 would result in net tax/NI of £5,883 – so the saving by taking a salary over dividends is £4,517.
HMRC will generally not accept 100% of a director’s salary costs within the R&D claim unless it can be clearly demonstrated that the director was exclusively involved in R&D activity.
While dividends don’t qualify as eligible staff costs for R&D claims, company pension contributions do. New pension freedoms make pension contributions a much more attractive option, so you might want to consider this as part of your remuneration package.
If a company makes pension contributions of £40,000 for the director and they spend 60% of their time on R&D, the R&D relief on this will be £55,200 (£40,000 x 60% x 230%). This means that the overall CT saving on the pension contribution will be £14,240 (((£40,000 x 40%) + £55,200) x 20%). As there’s no NI due on pension contributions, this is an even more efficient option than taking additional salary.
Get the best deal for yourself
For advice on the best split between salary and dividends or help with setting up a limited company and registering for VAT, please contact Alterledger.
Carrying forward unused pension annual allowance
Money that you pay into a UK registered pension scheme or qualifying pension scheme receives tax relief. Personal pension contributions are paid from your earnings after tax and the pension provider reclaims the 20% tax suffered. All employers will soon be required to offer pension schemes to employees, so now is a good time to think about what you can contribute to your pension scheme.
Anyone can make (gross) contributions each year of £3,600, but above this threshold the maximum you can put into the fund is 100% of Net Relevant Earnings (NRE). Tax relief on contributions is only available up to the Annual Allowance (including any Annual Allowance carried forward).
Any unused annual allowance can be carried forward provided you were a member of a registered pension scheme, or qualifying overseas pension scheme during the year. The carry-forward relief can be used for any unused allowance from the previous 3 tax years. Assuming you were a member of a pension scheme, but didn’t have any contributions (personal or employer’s) in the tax years from 2011-12 up to 2013-/14, it would be possible to have total contributions of £190,000 in 2014/15.
Net Relevant Earnings
- Earnings from employment
- Benefits in kind
- Self-employed profits as a sole trader
- Share of profits from a partnership
- Any profit from furnished holidaylettings
- Less allowable business expenses
Alterledger can help
Alterledger can explain the tax implication of pension contributions for employers and individuals. Contact Alterledger or visit the website alterledger.com for more information.
Since 6th April 2008 and until 3rd December 2014 Sole Traders and Parternships were able to claim Entrepreneurs Tax Relief on Goodwill when becoming a Limited Company.
Until the 3rd December 2014 they would claim there Capital Gains Allowance
|5 April 2013 to 6 April 2014||£10,900|
|5 April 2014 to 6 April 2015||£11,000|
Then claim ER which reduced the rate of tax to 10% on the gain.
But from the 3rd December they will now pay Capital Gains at the normal rates of CGT which are 18% or 28% (for Higher Rate Income Tax Payers).
This doesn’t change the potential ability of the company to offset goodwill against their Corporation Tax Return.
There are still other benefits related to goodwill as explained in this blog
Land Remediation Relief is a relief from corporation tax only. It provides a deduction of 100%, plus an additional deduction of 50%, for qualifying expenditure incurred by companies in cleaning up land acquired from a third party in a contaminated state.
The tax releif is available on both commercial and residential developments.
Qualifying Land Remediation Expenditure can be claimed for tackling pollution, natural issues, such as radon, arsenic or Japanese Knotweed or remediating long term derelict land.
Asbestos is a common issue and qualifies for Land Remediation Relief….
Legislation in The Control of Asbestos Regulations 2006 and The Control of Asbestos Regulations (Northern Ireland) 2007 governs the way that asbestos is removed.
As a result additional costs may be incurred in containing the asbestos and dust during removal.
For example, a licensed contractor must be employed to remove high risk material, such as pipe insulation or asbestos insulating panels.
The additional costs incurred in order to comply with the regulations are part of the cost of removing the asbestos and so may qualify for Land Remediation Relief.
So you don’t have to be Indiana Jones to discover value in your land…
The end of the tax year is just a few weeks away.
Gift Aid donations are regarded as having basic rate tax deducted by the donor. Charities or CASCs take your donation – which is money you’ve already paid tax on – and reclaim the basic rate tax from HM Revenue & Customs (HMRC) on its ‘gross’ equivalent – the amount before basic rate tax was deducted.
Basic rate tax is 20 per cent, so this means that if you give £10 using Gift Aid, it’s worth £12.50 to the charity.
A Gift Aid declaration must include:
- your full name
- your home address
- the name of the charity
- details of your donation, and it should say that it’s a Gift Aid donation
If you pay higher rate tax, you can claim the difference between the higher rate of tax 40 and/or 45 per cent and the basic rate of tax 20 per cent on the total ‘gross’ value of your donation to the charity or CASC.
For example, if you donate £100, the total value of your donation to the charity is £125 – so you can claim back:
- £25 – if you pay tax at 40 per cent (£125 × 20%)
- £31.25 – if you pay tax at 45 per cent (£125 × 20%) plus (£125 × 5%)
You can make this claim on your Self Assessment tax return
If you are a higher rate tax payer donations made in 2013/14 will save tax at 45 percent, but in 2012/13 the rate was 50 per cent.
You can ask for Gift Aid donations to be treated as being paid in the previous tax year if you paid enough tax that year to cover both any Gift Aid gifts you made that year and the ones you want to backdate.
So if you want to donate now (before the end of the tax year) you could claim back extra tax by carrying it back into the previous tax year.
Discorporation Relief is new, it came in to effect from 1st April 2013 and is currently available until 31st March 2018.
HMRC estimate that 610,000 businesses are eligible to use the Disincorporation Relief.
Here is the HMRC example from the Consultation document:
Window Cleaners Ltd a one man company that incorporated on 1 April 2004 and the shareholder, Mr Smith, had previously carried on the business as a self employed individual before 1 April 2002. Turnover is below the VAT threshold. The business has an established repeat customer base. The only significant business assets are a van, equipment and goodwill. The van and equipment are worth around £3,000 and the goodwill is valued at £15,000, together worth £18,000. The goodwill was acquired from Mr Smith for £5,000 on 1 April 2004. The Capital Gains rules apply and Corporation Tax is payable @ 20 per cent.
Tax chargeable on goodwill:
If the assets are distributed back to the shareholder (Mr Smith) on 1 February 2012 the following charge would arise on the goodwill:
· Corporation Tax on goodwill gain £8,540 (£15,000 – £5,000 less indexation £1,460 (£5,000 x 0.292)) @ 20 per cent = £1,708
There is no Corporation Tax to pay on any gains made on the transfer of the van and equipment because these are chattels worth no more than £6,000.
Mr Smith will also have to consider what tax he will have to pay on the value of the distributed assets of £18,000. The amount of charge will depend on whether the assets are treated as income or capital.
If distributed as capital, the actual amount of Capital Gains Tax that Mr Smith will have to pay will depend on a number of factors, including how much was paid for the shares, whether incorporation relief was claimed, whether Entrepreneurs’ Relief conditions are satisfied and availability of capital loss relief.
Assuming £100 was paid for the shares, that Mr Smith has no other gains in the tax year (and so the annual exempt amount of £10,600 can be used against the gain) and that he is entitled to Entrepreneurs’ Relief, then the amount of Capital Gains Tax to pay would be:
· (£18,000 – £100 – £10,600) x 10 per cent = £730
If the assets are distributed as income (i.e. a dividend) Mr Smith will only have to pay Income Tax if any part of the dividend is liable to Higher Rate Tax.
Criteria to qualify for disincorporation relief
Below is a basic summary of the main qualifying criteria:
- The company must have been operational for 12 months and the shareholders must have held their shares for 12 months
- The business must be transferred as a going concern to the existing company shareholders
- The transfer must become effective before 31st March 2018
- All assets, including goodwill, capital assets, trading stock and cash, must be included in the transfer. The value of those assets must be no greater than £100,000
- Recipients of the new “disincorporated” entity must either be individuals or partnership members (not members of an LLP)
Why would you want to disincorporate?
- Reduced compliance – Company Accounts, Corporation Tax Returns, PAYE, Annual Returns
- Reduced Costs – Accountancy Fees
- Cash Based Accounting
Lets start with a typical scenario:
- Mr Smith has been running a small garage for a few years
- he decides to incorporate his business and sets up Smiths Garage Limited with himself as the sole director and shareholder
- he transfers the goodwill of the business and its other assets and liabilities to Smiths Garage Limited but does not claim incorporation tax relief under Taxation of Chargeable Gains Act (TCGA) 1992, s162, nor does he claim hold-over relief under TCGA s162
- at the time of incorporation, the goodwill of the business is valued at £100,000
- Mr Smith makes a chargeable gain on the transfer of the goodwill, which is deemed to be at market value, of £100,000 which, after deducting the annual CGT exemption (£10,900 2013-14), will be taxable at 10% due to the availability of entrepreneur’s relief
- the company will pay Mr Smith £100,000 for the acquisition of goodwill and this is done by way of a credit to Mr Smiths director’s loan account. Mr Smith is able to draw down on this account without any further tax charges.
In addition Mr Smith started his Sole Trader business after the 1st April 2002 so he can claim a corporation tax deduction for amortisation of the goodwill in the company accounts. Small Companies pay Corporation Tax at 20%, so being able to deduct Goodwill on £100,000 will save £20,000 in Corporation Tax.
However, please bear the following in mind:
- If the business started before 1st April 2002, Corporation Tax Act 2009 s895 prevents the company from claiming a deduction against corporation tax, also refer to HMRC Spotlight 1: Goodwill – companies acquiring businesses carried on prior to 1 April 2002 by a related party
- Where a trader transfers his business to a limited company of which he is a ‘substantial shareholder’, the parties are treated as ‘related parties’ and the transfer must be at market value, but you can ask HMRC to carryout a post transaction valuation check by submitting form CG34
- Goodwill relating to personal services is not normally considered to have a market value as it can not be transferred
- In general it is expected that intangibles will have a useful life of no more than 20 years
- Get professional advice to help you to prepare the valuation, disclose the capital gain and claim the tax relief