Company Directors: Getting money out of your company tax efficiently...Check out this alternative to Pensions

Company director-shareholders are always on the lookout for ways to extract money from their business - tax efficiently.

With income tax rates on dividends having recently increased, many are put off from taking dividends beyond what they absolutely need to draw on.

Historically, company Pension contributions have been a popular way to take money out of a business, and understandably so. Company contributions are a deductible expense on the company, reducing corporation tax and the Pension contribution itself builds up retirement benefits for the director/shareholder.

However, the rules around Pensions are somewhat restrictive. The maximum contribution into a Pension is ￡40,000 per year. (Carryback is available if the last 4 years' contributions are unused, allowing a total contribution of ￡160k to be made in one go), and the funds are locked up until age 55 at the earliest. While 25% of this is available as a tax-free lump sum (known as Pension Commencement Lump Sum), withdrawing the balance of the funds are subject to income tax at your highest rates. Furthermore, when taking Pension benefits, if one accumulates a total Pension fund value of over ￡1.0731m - the current lifetime allowance, then swingeing tax penalties kick in.

So, is there an alternative to taking larger amounts out of your company efficiently, without having to lock it up in a Pension?

Previously, we've written about the generous tax benefits of using Venture Capital Trusts (VCTs) to extract money from a business.

Quite simply, that article talks about...

1. Taking a dividend from your business of up to ￡200k per shareholder.
2. Immediately investing it in a VCT (￡200k is the maximum each tax-year).
3. The VCT immediately gives income tax relief of 30%, offsetting the income tax incurred in 1. above - straight off the bat. After this 30% relief, you'll therefore either pay just 3.75% net if you're in the higher rate tax band, or a maximum of 9.35% if you currently are, or become, an additional rate taxpayer. This in itself is a substantial tax saving, allowing each shareholder to take out substantial sums from their business, really efficiently.
4. Now, the VCT investment must remain in place for 5 years (otherwise the income tax relief is clawed back). After the 5-year point, one can take the money and run for the hills - the proceeds of a VCT are free of CGT! So, that in itself is a remarkably efficient way of getting ￡200k per shareholder out of a business, without having to wait until retirement age to get your hands on the funds - and the proceeds of the VCT are completely free of CGT, and there's no income tax unlike taking income withdrawals from a Pension beyond tax-free cash.

Yet, in this article we can take this whole concept a step further to really supercharge the tax relief available using a little know secret around VCTs...

Once a VCT has been held for 5 years, the default option is to leave the funds invested.

But, did you know, if you sell the VCT at that point, and re-invest it, (in another VCT immediately, or the same VCT fund after 6 months), you will collect 30% income tax relief again - for the second time - on that same investment! That's the leverage of recycling for you.

Now going back to our company director scenario. Imagine at the end of year 5, recycling that VCT. That would give an immediate and second round of 30% income tax relief. Now that director can take a dividend, but with 30% income tax relief already in the bag offsetting the income tax on it, one can keep the dividend and use it as they please - with no need to invest it in a VCT!

Let's put some figures on this to illustrate how powerful this can be.

Selling a ￡200k VCT taken out 5 years previously, and re-investing it will generate income tax relief of ￡60,000 for the current tax year.

Now, for a company director on a PAYE salary, of say, ￡100,000, taking a dividend of ￡157,000 will ordinarily incur....drum roll....a ￡60,000 tax bill.

BUT with ￡60,000 tax relief already in the bag that director will pay ZERO income tax on that ￡157k dividend!

As if this isn't compelling enough, we can take this concept even further.

Imagine taking a dividend from your business each year over a 5-year period, and investing each one right away in a VCT. From year 6 onwards, one can recycle each VCT as it passes its respective 5-year point, thereby generating a 30% income tax credit annually, allowing that director-shareholder to take dividends - paying zero income tax - every year, ad-infinitum - which they can keep and spend (or save) entirely as they wish!

Well, what about the risks in a VCT, I hear you ask?

Well, VCT performance may surprise you. It quite interesting to reflect that VCTs actually diversify away from stock market related investments, and sticking to long-established VCT funds with a good track record can often deliver investment returns which arguably are less volatile than a typical balanced managed equity fund!

Check out these long-term charts of 2 VCT funds offered by different providers; notably, both funds have risen in value in 2022, while most equity investments are down significantly!

Don't forget, the tax relief is in addition to the investment returns shown above.

With such compelling tax and investment benefits, the power of VCTs should not be ignored.

And, don't forget. It's important not to do a DIY job when investing in such vehicles. Such an investment strategy should not be undertaken in isolation. Getting appropriate investment advice from an experienced financial planner who can consider your overall circumstances and as well as work closely with your accountant pays dividends in the long run - quite literally!

Let us help you.

By Arnold Aaron, Specialist Inheritance Tax Planning & Investments

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. The investment returns shown above are gross i.e. before any annual management fees, product charges or advice fees have been taken into account.

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

Arnold Aaron is a trade 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.

The information on this webpage is subject to the UK regulatory regime and is therefore targeted at consumers based in the UK.