Accountants: Are your clients building up excess cash in their business? Check out these solutions, including tax-efficient dividend strategies.

Accountants: Do you have clients building up excess cash in their business?

Check out some of these solutions we advise on, one of which could potentially allow husband-wife directors/shareholders the ability to take dividends of almost ￡400,000 every year with no income tax liability! Sounds too good to be true? Read on...

As a Financial Advisory firm established over 25 years ago, and licensed to give investment advice, we have a wealth of experience in addressing issues commonly facing clients - in particular company directors.

For company directors accumulating cash, here are some options available, which we frequently advise our clients.

Where long-term funds are to be retained in the business;

Firstly, where retaining cash in the business is desired over the long term, one reputable life company offers businesses a low-risk/low-volatility investment that offers a return of 6.9% per annum (gross of fees). However, the real 'take-away' here is that this is structured as an onshore life fund, and so this return is 'deemed' to have already paid corporation tax at 20% at source - so for companies with a corporation tax rate of 20% or less, there is no further tax-liability on these returns! That's an equivalent gross return of 8.63% per annum - a very respectable return for a low-risk investment. (Companies with a higher corporation tax rate, for example, those in the highest band at 26.5%, would simply pay just 6.5% corporation tax on gains, which is still a significant tax saving). Although this investment should be intended as a long-term investment, the funds are accessible at any time.

Where one wishes to take cash out of the business; Company Pension Contributions - This is a well-trodden path and one we frequently recommend to clients as a first port of call, and is extremely tax efficient. However, for those with a high level of earnings, which include dividends, Pension contributions may be limited. Another aspect to consider is the fact that Pension income is subject to income tax, beyond any Pension commencement lump sum. Furthermore, those with particularly large Pension funds, are limited to maximum tax-free cash of ￡268,275. So is there an alternative to consider?

Our forte...taking dividends from the business...using long-term tax-efficient investment strategies (Grab a cup of coffee for this bit, and find out how 2 director/shareholders can ultimately take ￡300k in dividends every year, with no tax liability!)

Dividends are taxed at 39.35% at the highest rate. With the high cost of living these days, it does not take a particularly substantial dividend to break into this additional rate. Nobody likes seeing almost 40% of their hard work washed away in income tax, so is there a way to mitigate this tax burden?

One long-term tax planning strategy we have devised and on which we provide full advice, often working closely with clients' accountants, works as follows;

A dividend is taken from the business and immediately invested in a specific FCA-regulated tax-efficient investment that we advise on, which instantly provides 30% income tax relief on the amount invested. This tax relief recovers most of the income tax incurred on the dividend. HMRC rules stipulate that this investment must remain in place for 5 years.

After the 5-year point, the proceeds of this tax-efficient investment become available, and can be cashed in, free of CGT. So, there you have it, an efficient way of taking money out of the business.

But, wait!

The showstopper here is the fact that the dividend is not available until the 5-year point. Most would find this an impractical way of taking dividends.

Most directors would say, 'Show me the money now!'

Understandably so. Ahh, but patience is a virtue.

This is where our dividend strategy really comes into its own. The tax-efficient investment that matured after 5 years can in fact be recycled, i.e. by selling the investment and re-investing it back into the same vehicle. Recycling would generate a 2nd round of 30% income tax relief on the original funds which were invested 5 years earlier. (There are specific HMRC rules that must be followed to ensure the recycling qualifies again for tax relief - for which we provide full advice).

So, in year 5, let's assume we recycle that investment, and in doing so, we receive 30% income tax relief. With the tax relief in the bag, one can now go ahead and take a fresh dividend from their business, and simply offset it against the tax relief generated from the recycled investment - thus allowing one to take a dividend with net-zero income tax liability, where the funds can be used immediately - with no requirement to lock up this new dividend in an investment.

Let's weave all of this together, with some figures to illustrate....

In Year 1, a director/shareholder takes a dividend of ￡200,000. Ordinarily, this would trigger an income tax bill at a maximum rate of 39.35%. However, with the ￡200,000 immediately going into our investment vehicle, 30% income tax is recovered immediately. The dividend and tax relief from the investment are declared on the same tax return, offsetting one against the other, so in our case, the director-shareholder will pay no more than 9.35% tax on taking this dividend but could be less in some cases, depending on how much other income one has.

After 5 years, the ￡200,000 investment is 'recycled' (we alert our clients, provide full advice, and take care of every step of the process), which generates another round of 30% income tax relief - let's assume the original capital of ￡200,000 is recycled.

This would generate income tax relief of ￡60,000 for the 2nd time on the original capital. Now, we simply offset this tax relief against a new dividend from the business, which can be used/spent/saved (or frittered away!) as one wishes.

So, how big a dividend can one take which would trigger off a ￡60,000 income tax bill, and therefore leaving a net-zero income tax liability?

Here are the figures:

For a director on a PAYE salary/total income of ￡100,000, taking a dividend of ￡157,000 would incur an income tax liability of ￡60,034.

For one with a PAYE salary/total income of ￡10,000, taking a dividend of ￡187,000 would trigger an income tax bill of ￡60,124.

If one had no other income at all, one could take a dividend of ￡194,500 which would trigger a tax bill of ￡60,015!

The numbers are quite staggering - the ability to take such substantial dividends with zero income tax liability!

So, how do we maximise this, and how on earth do we get to almost ￡400,000 every single year, tax-free?

We simply repeat the steps above annually for the first 5 years, by taking a dividend every year during years 1 to 5, and immediately invest it in our tax relief vehicle.

Then from year 5 onwards, the recycling can work its magic, as each individual investment passes its 5-year anniversary. In the case of 2 shareholders, for example, a husband-wife company structure, the figures above are simply doubled, allowing both shareholders to take a total dividend of anywhere from ￡300,000 to ￡389,000 each year, paying zero income tax!

So there you have it. A long-term investment strategy allowing one to take substantial dividends from their business extremely tax efficiently, and one which we frequently advise and implement for clients, every step of the way.

A quick word on investment risk. While our tax relief investment vehicle is classed as a higher-risk investment, it is worth observing the fund performance of two such funds (among many) available in this tax-relief space, which have provided consistent returns over the last 15 years, including during the worldwide equity bear market of 2022.

So, if you have company director clients who have asked you what to do with the cash building up in their business, get in touch and let us put a tax-saving strategy in place for your clients.

Contact:

Arnold Aaron

Specialist Inheritance Tax Planning & Investments

78 York Street,

London W1H 1DP

T: 0207 692 0884

arnoldaaron.co.uk

e: [email protected]

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes that cannot be foreseen.

The value of investments and any income from them can go down as well as up and you may not get back the original amount invested. Past performance is not a reliable indicator of future results.

Arnold Aaron is a trading name of Arnold Joseph Aaron who is an appointed representative of The Openwork Partnership which is a trading style of Openwork Limited which is authorised and regulated by the Financial Conduct Authority.