As a business owner, your focus may simply be “pay myself a salary, take dividends, pay the tax bill.” However, once the business starts to build, you may find that purely making profit becomes far less of a problem. At that point, the question about your business becomes: what now?
It’s something we (happily) discuss quite often with small business owners whose businesses are enjoying growth. So, here are four key strategies to look at when profits aren’t an issue anymore.
Beyond salaries and dividends
This article assumes you’re already aware of how to use salary and dividends to achieve the best tax benefits. If not, there is lots of information right here on our website to help you.
Strategy #1: Turn “your” expenses into company expenses
As a business owner, you probably pay for items and services that are for both personal and business use, such as your mobile phone.
If you are already paying for your mobile yourself, you could potentially half the cost to you if the company took out the contract instead. This is because the money to pay for the phone comes out of your company before tax. If you pay it yourself, the money will come from your already-taxed salary or dividend.
While the gains from just switching to the company paying you mobile bill may seem minimal, the compound impact of applying this principal across other potential ‘switchable’ expenses can really mount up. Over a year, this switching strategy can reduce many costs by about half compared to paying them personally. When done correctly it can also reduce the company tax bill too.
So also look at:
- Relevant life insurance
- Your coffee, cake and fruit
- Your car
- Your counselling (!)
- Paying your children for genuine help they’re giving to the business (rather than giving handouts or allowances).
It may be tempting to try this for all sorts of services and items you could get the company to pay for, but always remember
Do not spend money just to save tax.
Instead, focus on switching expenses and items you were already buying, to pay for them in a more tax-efficient way where possible. See our Tax Funnel Framework Guide for more details.
IMPORTANT: There are many caveats to this, namely is the company allowed to pay for this without causing you a personal tax issue? Some expenses do have tax-free exemptions, such as a mobile phone, but many do not. Talk to your accountant or check the Tax Funnel guide for more ideas.
Strategy #2: Organising the company’s cash
Key to helping your company stay healthy and making profit, you need to be certain it can:
- Pay its tax bills
and
- Fund its growth.
Paying tax and VAT bills
A common approach is to earmark cash, or a certain percentage of cash to pay these bills. Many business owners set up a separate reserve bank account, completely separate from the trading account, and move a percentage of profits into this account purely to pay tax and VAT.
You’ll need to put around 25% of your profits into a reserve account to pay your corporation tax bill.
VAT is calculated slightly differently. For every £100 your business receives, the amount normally due for VAT is £16.67, not £20. This is because 20% VAT is due on the net price. What you’re receiving is the gross amount. Therefore, if someone pays you £100, £83.33 of that is yours and £16.67 is HMRC’s.
Most VAT-registered businesses should put aside 17% of everything received in a separate account to pay the VAT bill. If you have a small business and don’t invoice that often, you may prefer to move the exact VAT amount across into the account at point of invoice instead.
Top tip! To work out the exact VAT amount, you could just divide the gross figure by 6.
Funding growth and growing wealth
Once the tax and VAT bills are accounted for, what you choose to do with the rest of the company’s profit is up to you as the owner (or your board). Common solutions we discuss with owners are:
-
- A growth fund, setting aside money to invest back into the business, and fund new employees, new equipment, marketing campaigns, etc.
- A wealth fund that builds your personal or business financial wealth over time (more on this in section #4).
Both these can be set aside by either fixed amounts or percentages, for example:
-
- 10% for a growth fund
- 5% for a wealth fund
Important: To get the most from this strategy, you’ll need a good understanding of your numbers and profit margins. Talk to your accountant or talk to us if your accountant doesn’t have the experience to advise on this.
Strategy #3: Pensions
Disclaimer: As accountants we cannot give regulated financial advice. The following section is not investment advice, but simply describes what we have seen clients do, and how it reduces tax.
Strategic pension contributions can be a tax-efficient way to increase your personal wealth further. So, you might decide to use some of your wealth fund (see below) to enable your company to pay into your pension scheme as your employer.
The key point here is that you don’t have to contribute personally as well . As the company’s contribution is usually tax deductible, this can create a substantial saving in the year the contribution is made.
There are annual limits, currently £60,000 per tax year for most owners. That’s a substantial amount of money that you could potentially move from the company into your own pension. Our clients have shared with us that, before making a contribution, business owners like you should weigh up:
- How you view pensions as an investment
- If you are comfortable with your money being inaccessible until pension age
- Recent changes to inheritance tax and pensions
Strategy #4: Protecting and growing wealth through a holding company
If you have sizeable amounts of money accumulating in the company, you will want to protect it. For example, you might want to spread cash across different banking institutions, just in case one institution goes down. (We’ve been in business long enough to see this happen more than once.) The key reason for this is that the FSCS bank protection scheme only covers £120,000 of your cash. So, if you have more than this in your bank, it’s at risk if the bank get into trouble.
As your business grows, it’s likely you will need to hold more £120k in a single bank account to trade. However, with excess profit funds or provisions, you may consider moving this money with the £120,000 limit in mind.
Holding companies to ring-fence money
Beyond that, a major strategy is to “ring-fence” the money in a holding company. Instead of you personally owning your trading company, you create a new limited company (the holding company) which is a separate, protected entity. You own the holding company, and the holding company owns the trading company.
How holding companies work
The trading company pays its profits (from your wealth fund) ‘upwards’, which essentially moves cash into the holding company. This is a legal way to move money out of your trading company, where it’s exposed to things like litigation if something goes wrong. The trading company can also pay upwards via dividends (if available), so the holding company usually receives that money completely tax-free.
As a separate entity, the holding company can be used to generate a return on the monies it holds by, for example by:
-
- Investing in shares or funds
- Buying property
- Acquiring another business. The holding company buys the shares of another business, that business joins the group, and hopefully starts paying its profits upward too.
However, there are costs associated with this strategy, including:
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- An additional set of accountancy fees
- More administration for business owners
- Owning more limited companies can sometimes actually increase your overall corporation tax bill
For more details see our blog here:
Bringing it all together
To summarise, as a small business owner making reliable and sustainable profits, it’s time to look at ways to:
- Get the company to pay for things you’d pay for anyway (where you can)
- Get company cash properly organised with reserves
- Build wealth in your pension
- Use a holding company to generate further returns
If cash is building in your trading company, talk to your accountant or if it’s a little beyond them, contact us. We’ve been there, and helped numerous business owners move onwards to make the most of ‘what’s next’.
About the author
Dan Heelan is the Business Services Director of Heelan Associates, an accounting firm that helps small business owners across the UK start, survive, and grow.
With a background as a small business owner himself, he discovered his passion for accounting and tax early in his journey and now focuses on empowering fellow entrepreneurs with the knowledge and tools to navigate the financial side of running a business.
You can see and hear Dan in action in his regular: