Tax tips for Family Businesses
Find out how family businesses can reduce their tax burden with some practical forward thinking.
Owners and managers of family-owned businesses rightfully spend the vast majority of their time ensuring that the business runs well and generates profits. In the midst of such a demanding task, it can be easy to overlook some tax considerations that can potentially be significant.
The topic of tax in the context of family-owned businesses is a large one – however, there are a few key considerations to bear in mind:
- How is your business set up?
- How are you extracting funds?
- What’s New?
- How are you incentivising your staff?
- Are you thinking of an exit?
- Planning with pensions
- What about the next generation?
How is your business set up?
Most family-owned businesses are set up as companies, but some do run as partnerships. These two structures differ in terms of tax, and it is worthwhile for business owners to consider which structure could be most beneficial for their business.
Companies may pay lower rates of tax initially, but further tax (including National Insurance Contributions in the case of salary/bonuses) is often due when higher profits are extracted. Partnerships however are tax transparent, so profits are taxed as they arise, even if they are not extracted (but are taxed only once). It is generally easier to convert a partnership into a company than the other way around.
How are you extracting funds?
The business has a choice, broadly speaking, of paying dividends or paying salary/ bonuses. However, recent legislation has attempted to narrow the tax difference between companies and sole trader/partnerships.
The Finance Bill 2016, published on 24 March 2016, contains the new rules for dividends.
- From 6 April 2016, the notional 10% tax credit on dividends will be abolished
- A £5,000 tax free dividend allowance will be introduced
- Dividends above this level will be taxed at 7.5% (basic rate), 32.5% (higher rate), and 38.1% (additional rate)
- Dividends received by pensions and ISAs will be unaffected
- Dividend income will be treated as the top band of income
- Individuals who are basic rate payers who receive dividends of more than £5,001 will need to complete self assessment returns from 6 April 2016
- The change is expected to have little impact upon non-UK residents
The proposed changes raise revenue despite the so-called “triple lock” on income tax. Perhaps aimed to tax small companies who pay a small salary designed to preserve entitlement to the State Pension, followed by a much larger dividend payment in order to reduce National Insurance costs. It appears that the government is anti-small companies, preferring workers to be self-employed.
These changes will affect anyone in receipt of dividends: most taxpayers will be paying tax at an extra 7.5% p.a. Although the first £5,000 of any dividend is tax free, in 2016/17:
- Upper rate taxpayers will pay tax at 38.1% instead of an effective rate of 30.55% in 2015/16
- Higher rate taxpayers will pay tax at 32.5% instead of an effective rate of 25% in 2015/16
- Basic rate taxpayers will pay tax at 7.5% instead of 0% in 2015/16
This measure will have a very harsh effect on those who work with spouses in very small family companies. For example, a couple splitting income of £100,000 p.a. could be over £5,000 p.a. worse off.
Businesses should therefore consider these tax issues when using either of these methods to extract funds.
There can be benefits in various family members being involved in the business, particularly if they, for example, perform smaller roles and are not paying taxes at the higher rates. Care is always required here to ensure that any salaries are commensurate with the job performed.
There can also be complexities in giving away shares to spouses to enable them to capture dividends at the lower rates.
How are you incentivising your staff?
Clearly, the retention of key staff is of critical consideration for businesses of any size. With cash flows being restricted in these difficult times, consideration can usually be given to granting share options to employees. Certain tax-approved options schemes (such as Enterprise Management Incentives) are potentially very tax-efficient and a good incentive for key workers.
Are you thinking of an exit?
It is never too early to contemplate what would happen if the business were sold. The headline rate of capital gains tax is not good as it once was but there are potentially reliefs available which may minimise the tax burden on exit. With the right structuring, valuable relief can potentially be opened up to various family members through tax planning.
Tax Planning with pensions
Pensions are all the rage now, given the recent changes.
In certain instances, an appropriate pension plan for a family-owned business can lead to substantial tax efficiencies. Also the use of SIPPs and SASSs can be used a valuable tax planning tool to extract funds from otherwise taxable business profits.
What about the next generation?
Succession planning is a key strategic matter for any family-owned business. Where the business is a trading concern, it is often possible (depending on the particular circumstances) to give away shares without adverse tax consequences.
But care is required here to avoid certain pitfalls that can exist if even a few investment assets are located somewhere within the business.
It may also be the case that a trading business qualifies for inheritance tax relief (under the business property relief regime); therefore, founders may not be worried about inheritance tax now. If the business is sold however, this relief will be lost, potentially generating a significant inheritance tax bill in the future. Fortunately, planning options do exist here, such as transferring the business into a trust before an exit.
Needless to say, the above gives only a taste of some of the relevant tax considerations where family-owned businesses are concerned. The important point is to remember the significant impact that tax can make, and to take advice early and regularly.
Latest news & blogs…
What with cyber-snooping being all the rage these days it seems the taxman is getting in on the act too.
HM Revenue & Customs has now fully unleashed its super-computer, costing over £100m and many years to make, to identify those who may have paid too little tax.
The powerful system, benignly dubbed “Connect”, now automatically gathers information from a myriad of government and corporate sources to create a detailed profile of each taxpayer’s financial position. Where this differs from the information provided by the taxpayer, the account is flagged up and subject to further possible investigation.
Connect now automatically collects information from over 30 databases, covering details of taxpayers’ salaries, bank accounts, loans, property and car ownership..
The system’s data-hoarding does not just stop at the income people have received from work and investment. It also amasses data from the digital footprint left by taxpayers online.
It collates data from diverse sources such as Airbnb and eBay, as well as obtaining anonymised information on all Visa and Mastercard transactions, enabling it to identify areas of likely underpayments which it can then target further.
HMRC also has powers to request one-off bulk data from third parties where there may be particular cause for concern. Insurance companies, hospitals and dentists supplied information to assist with the Tax Health Plan, for instance.
For those with investment properties, it can also access Land Registry records to see houses purchased/sold to check against information on a tax return. In addition, further sources enable it to determine if properties are being rented out and whether that income has been declared. Crucially, it can also determine if someone is likely to be able to afford such properties, or whether they are suspected of having used previously undeclared income or savings.
Particularly striking is the gathering of information from social media. HMRC are now monitoring online posts about holidays, parties and purchases. They may wish to ask questions where they do not feel lifestyle fits with an individual’s reported income.
The tax profession has raised concerns that HMRCs growing reliance on automated systems could mean an increasing number of innocent taxpayers facing investigation. Whilst many of the leads generated by Connect’s data collection maybe worth following up, a proportion will be unfounded causing unnecessary stress and anxiety to those targeted. A surface analysis of data or online information could quite easily lead to misinterpretation. An exaggeration over twitter or Facebook, for example, could paint a highly inaccurate picture resulting in false leads.
Shipleys Tax has many years of protecting taxpayers and succeeding in tax investigations with HMRC, if you need help please contact us 0114 275 6292 or email email@example.com.
What HMRC can find out about you
- UK & overseas bank accounts, pensions: From 2017 HMRC will receive information from banks in more than 60 countries.
- Web browsing and email records: Under the ‘Snoopers Charter’ HMRC will be able to access individual’s digital information
- Property sites -adverts on the internet e.g. Rightmove and Zoopla
- Land Registry records: To determine properties purchased, stamp duty paid and capital gains tax
- Earnings: From any employer, including those you have worked for casually, or on an ad-hoc basis. This includes any company benefits received. It can also access child benefit and maintenance payments through the child support agency
- Internal tax documents: Systems show council tax paid, relevant VAT registration, previous tax investigations, last year’s tax return (or absence of one)
- Visa and Mastercard transactions: Anonymised information on all payments
- DVLA: Details of cars purchased and owned by individuals
- Online marketplaces: Websites such as eBay and Gumtree can be accessed to weed out regular traders
- Social media: The Connect system can also look at public social media account information, including from Twitter, Facebook and Instagram
Connect cross-references information from many other UK government databases, including:
- Council tax
- Companies House
- DWP (former Benefits Agency)
- The electoral roll
- Gas Safe Register
- Insurance companies
HMRC also independently looks at Google Earth.
If your child is under 12 and you’re not working or don’t earn enough to pay National Insurance contributions, Child Benefit can help you qualify for National Insurance credits.These credits count towards your State Pension. They protect it by making sure you don’t have gaps in your National Insurance record.
Retirement may be the last thing on your mind when you’re looking after a new baby, but what you do now could have a big impact on your future finances.
Despite what you might think, no one automatically gets the full amount of State Pension when they retire. You’ll only get the full amount if you’ve paid, or been credited with, National Insurance contributions for 35 years.
The key word here is ‘credited’. Even if you’re not working while looking after your baby, you’ll get National Insurance credits when you claim Child Benefit until your youngest child is 12. The credits are automatically added to your National Insurance account when you claim Child Benefit, so you don’t need to do anything.
For more information please contact us on 0114 275 6292 or firstname.lastname@example.org.
The Finance Bill 2016 finally received Royal Assent on 15 September, enacting proposals announced in the 2016 Budget, Autumn Statement 2015 and Summer Budget 2015. Amongst other things, Finance Act 2016 includes provisions relating to income tax rates and allowances; restrictions on tax reliefs for travel and subsistence expenses (in effect since April 2016), the reduction of the lifetime allowance on pension contributions from £1.25m to £1m (again, effective from 6 April 2016); and the reduction in the main rate of corporation tax to 17% for financial year 2020.
The Act is based on George Osbourne’s final Budget. The annual Finance Bill usually receives Royal Assent in early to mid-July. This year’s extensive delay has been largely blamed on the Brexit referendum followed by the summer parliamentary recess.
The Finance Act 2016 can be found online here or alternatively you contact us for more information.