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Published 10 November 2020
It is easy to ignore tax structuring when focussed on winning business and generating revenue. Tax will never be the most important factor in the success of your business, but a little bit of tax planning can make a big difference.
If you are setting up a company, consider giving shares to your spouse / civil partner or wider family. Every individual can receive £2,000 of dividends tax free at present in addition to their tax free personal allowance of £12,500. The starting rate of tax is then just 7.5% on dividends (compared to 20% on income). If you give to someone other than your spouse / civil partner, so long as this is a trading company you won’t have to pay tax on the gain (but there is a form to fill in).
You make £75,000 as a sole trader. You will take home £53,120 after income tax and NIC, a total tax burden of £21,880 (an effective tax rate of 29.2%).
If operating through a company where you took a small salary yourself (£8,788 – qualifying you for state pension entitlement and not attracting any personal tax, while also being tax deductible for the company) and split dividends evenly between you and your spouse the company would pay £12,580 corporation tax, you would pay £2,054 income tax and your spouse would pay £1,395. Total tax burden - £16,029 (an effective tax rate of 21.4%). This saves you approximately £6,000.
While the tax savings above can be compelling, remember that giving away shares in your company carries other risks. What if your spouse decided to vote against you for example. There are solutions to problems such as this. Also think about inheritance tax and who needs the money. It might be more efficient to give shares to your children, for example, as well if done properly.
You align their reward with the company’s success. The best game in town in terms of share options is the “EMI scheme”. You grant key staff options over shares in your business to encourage them to grow the company. You can tailor this how you see fit, commonly options are only exercisable on an “exit” (a sale / listing / takeover of your business) and the number of shares staff are entitled to might depend on performance conditions for the business generally (e.g. a sliding scale depending on turnover or achieved sale price) or personal targets (e.g. sales figures achieved).
Options do not allow staff to vote or participate in dividends. They can fall away if staff leave. They allow staff to directly benefit from any increase in company value on sale however, at a very tax advantageous rate of 10% (providing options or resulting shares are held for at least 2 years and on the first £1million of gain). Once you factor in the corporation tax deduction of 19% EMI options can effectively achieve a negative 9% tax rate (i.e. a tax refund).
Five staff are given options over 100 shares each exercisable at their current market value of £1 per share. Three years later the company is bought out at a price of £1,000 per share.
The five staff pay £100 each for their shares and receive £100,000 each on sale. They pay 10% capital gains tax after their annual CGT allowance (they can qualify for “entrepreneurs relief”, despite possibly not holding 5% of your company each, as EMI options have special benefits). Ignoring the annual allowances (which would further reduce their tax) and rounding up, each staff member pays £10k CGT (total CGT £50k). The company can deduct from its taxable profits the difference between share value (£500,000) and price paid (£500). At 19% corporation tax that allows for a corporation tax deduction of c£95k. That saving might encourage your buyer to pay a little more for the company, or to do the deal in the first place, which will benefit you and every other shareholder.
You make their potential investment more attractive by offering either EIS or SEIS relief. These reliefs allow investors to receive back 30% of their investment (through EIS) or 50% of their investment (through SEIS) in tax relief from the government, hugely de-risking their investment.
As an added perk, investors would not pay CGT on an eventual sale at a profit. EIS is only available to small relatively new companies however, and SEIS to even smaller companies, which by their nature will be risky investments. There are a few types of business which cannot benefit from EIS or SEIS. Investors need to leave their cash in for at least three years to prevent a clawback of their tax relief. There are numerous qualifying conditions but generally for the typical start up business EIS or SEIS relief is achievable and your company can obtain advance assurance from HMRC which it can show to potential investors. The max SEIS investment is £100k per investor (£150k company limit) and for EIS is £1m per investor (£12m company limit).
For an informal chat about any of the above (or any other tax point) you can contact one of our team.
London - Walbrook
+44 (0)20 7894 6330
+44 (0)20 7894 6697
+44 (0) 20 7894 6328
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