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Unpaid bills and unbilled work
As explained above, small businesses may opt into the cash
basis and calculate their profits on the basis of the cash passing
through the business. However, it is a feature of the tax system
that other businesses (including all corporates) must include
in their turnover for the year the value of incomplete work, of
unpaid bills (debtors) and of work completed but not yet billed,
all as at the end of the year.
We will need to discuss with you exactly what needs to be
identified and the basis of valuation. Keeping an eye on debtors
and unbilled work is very important to your cash flow.
Forming a limited company
Forming a limited company may be a consideration if the
limitation of liability is important, but it should be noted that
banks and other creditors often require personal guarantees
from directors for company borrowings.
Trading through a limited company can be an effective way
of sheltering profits. Profits paid out in the form of salaries,
bonuses or dividends may be liable to top tax rates, whereas
profits retained in the company will be taxed at 19%.
Funds retained by the company can be used to buy equipment
or to provide for pensions – both of which can be eligible for
tax relief. They could be used to fund dividends when profits are
scarce (spreading income into years when you might be liable to
a lower rate of income tax) or capitalised and potentially taxed
at 10% and/or 20% on a liquidation or sale.
National insurance contributions (NICs)
Leaving profits in the company may be tax-efficient, but you
will of course need money to live on, so you should consider the
best ways to extract profits from your business.
A salary will meet most of your needs, but you should not
overlook the use of benefits, which could save income tax and
could also result in a lower NIC liability.
Five key NIC-saving strategies:
• Increasing the amount the employer contributes to company
pension schemes. Care should be taken however as there are
limits on the amount of pension contributions an individual
can make both annually and over their lifetime
• Share incentive plans (shares bought out of pre-tax and
pre-NIC income)
• For some companies, disincorporation and instead operating
as a sole trader or partnership may be beneficial
• Instead of an increased salary, paying a bonus to reduce
employee (not director) contributions
• Paying dividends instead of bonuses to owner-directors.
Increasing your net income as an
owner-director
As an example, consider how much you might save if, as an
owner-director, you wanted to extract £10,000 profit (pre-tax)
your company makes in 2018/19 by way of a dividend rather
than a bonus. We have assumed in this scenario that the
director has already taken salary in excess of the upper earnings
limit for NIC, is a 40% taxpayer, and the £2,000 dividend tax
allowance has already been utilised.
Case Study
As you can see in this case study, the net income is increased
by 7% by opting to declare a dividend. Be sure to discuss this
with us, as this is a complex area of tax law.
Bonus
£
Dividend
£
Profit to extract
10,000
10,000
Employers’
NICs (13.8% on
gross bonus)
-1,213
Gross bonus
8,787
Corporation tax
(19% - dividend is
not deductible for
corporation tax)
-1,900
Dividend
8,100
Employees’ NICs (2%
on gross bonus)
-176
Income tax (40% on
gross bonus)
-3,515
Income tax on
dividend
-2,633
Net amount extracted
5,096
5,467
Remember that dividends are usually payable to all shareholders
and are not earnings for pension contributions and certain other
purposes. It is possible to waive dividends, although this can
result in tax complications. Finally, you need to consider with
us the effect of regular dividend payments on the valuation of
shares in your company.
Planning for the year end
Tax and financial planning should be undertaken before the end
of your business year, rather than left until the end of the tax or
financial year. Some of the issues to consider include:
• the impact that accelerating expenditure into the current
financial year, or deferring it into the next, might have on
your tax position and financial results