Effective profit extraction ― overview

Produced by Tolley
Effective profit extraction ― overview

The following Owner-Managed Businesses guidance note Produced by Tolley provides comprehensive and up to date tax information covering:

  • Effective profit extraction ― overview
  • Background
  • Summary of profit extraction options
  • Capital
  • Income
  • Practical profit extraction planning considerations
  • Retention of profits in the company
  • Extracting profits by way of salary and / or dividends
  • ‘Unearned’ income and NIC
  • Family members
  • More...

Extraction of companies’ profits will result in a tax charge and often national insurance contributions (NIC) being levied. Careful planning is crucial. This is generally a complicated exercise as there are many different factors to consider. As well as considering the tax impact of the chosen profit extraction strategy, it is important not to lose sight of the commercial, legal or long-term implications.

Guidance on strategies for profit extraction starts from Simon’s Taxes D6.640 onwards.

Background

Profits within a company will be taxed under corporation tax. Once profits are extracted, they are subject to taxation again in the hands of the individual owner. The rate and timing of the tax / NIC liability depends on the chosen method of profit extraction.

For further guidance on the calculation of corporation tax, see the Computation of corporation tax guidance note.

Summary of profit extraction options

There are a number of methods for an owner of a company to extract profit. These can be regarded as primarily falling into two categories: capital and income. These will often result in capital gains tax or income tax consequences, and the choice of profit extraction method may be specifically chosen according to the consequences.

Capital

The following are the methods generally used to extract capital, usually when the business has ceased, the owner has retired or is passing the business on to others:

  1. informal winding up, see the Informal winding up guidance note

  2. purchase of own shares, see the Purchase of own shares ― overview guidance note

  3. liquidation, see the Administration and liquidation guidance note

  4. proceeds from external sale, see the Tax implications of share sale guidance note

Income

The following are the methods generally used to extract income on an ongoing basis to provide funds for the owner:

  1. dividends

  2. salaries and bonuses

  3. benefits in kind (BIK)

  4. pension contributions

  5. loans from the company

  6. interest on loans to the company

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