Profits that are kept within a companies’ accounts are taxable under corporation tax. This is a tax that is chargeable upon a company as a way for them to pay their dues to HMRC. As a way to avoid high tax charges on profits, a company may choose to extract profits to reduce impact. It’s quite possible that this way of profit saving will become quite popular in coming months due to the scheduled increase in corporation tax levied on companies, from the current 19% to 25% on profits over £250,000.
However, profit extraction must not be taken lightly. Extracting profits from a company is a complicated process and can still result in high tax charges and additional NI contributions, if not planned meticulously and with consideration of various factors. One must consider possible commercial, legal and tax outcomes, both short-term and long-term, before any profit extraction can be carried out.
The two usual ways that a company may use to extract profit is through it’s capital or through it’s income. The methodology used would be entirely dependent upon their consequences, as both methods would be susceptible to income tax charges or capital gains tax charges.
Methods of Profit Extraction through Income:
If profits are to be extracted on an ongoing basis there are a few methods that can be used such as:
- Salaries and Bonuses
- Loans that have come from the company
- Pension Contributions
Methods of Profit Extraction through Capital:
However if the company is undergoing major changes such as the retirement of a person with significant control, the business is to come to a close or the company is to be passed onto another then profits could be chosen to be extracted through capital. This could be using methods such as:
- Purchasing of shares
- Proceeds through external disposals
Is Retaining Profits in the Company a Smarter Move?
Before undertaking tax planning to extract profits, one must also consider the other side of the coin. Namely, is it better to leave profits in the company rather than extract them? If certain business reliefs are to be claimed by building up cash balances then it may be a smarter move to retain profits to achieve this purpose, depending on whether the company meets the definition of a ‘trading business’.