Profit extraction strategies for owner managers in property & construction
As an owner-manager of a small company, it’s inevitable that at some point you will want to draw some cash from your business.
Some people will be looking for a regular income to fund their lifestyle, whereas others will want to take ad-hoc cash as required or when it’s available.
However, if you’re a director of a limited company, there is an element of planning to be done to ensure that the money you draw is both tax-efficient and strategically feasible for the company.
12th January 2021
Amy Chapman See profile
The first point to consider is actual available cash.
For rental businesses, there is more likely to be a steady inflow of cash where payments are made regularly. However, any delays in payments from your tenants could cause issues. This has been a particular issue recently with some renters, both residential and commercial, struggling with their own cash flow – causing a knock-on effect.
If a rental business sells a property it will of course have a large cash inflow and will need to plan to extract this efficiently.
Construction businesses may find that cash flows are uneven – income can fall at the end of a project which can last many months. Staged payments could be negotiated, or factoring used to even this cash flow out.
Property development businesses will usually have cash outflows for many months or years before the first cash inflow. Usually some sort of financing is therefore required – either from a director or a lender.
It should be noted that even if a director declares a salary or dividend payment, this doesn’t have to be physically drawn if the cash position means it’s not possible for the company to do so. The remuneration isn’t lost – it sits in the Director’s Loan Account to be drawn at a later date.
If a company has sufficient cash, we also need to consider reserves before any dividends can be declared. The reserves of a company are, typically, all the profits and losses that it’s ever made combined, less any dividends (distributions of profit) that have been declared.
The total reserves of the company usually represent the maximum dividends that can be declared. In the opening years of a property development company, there may be cash in the bank from a lender or director’s loan, but the company would still be making losses. In this instance, no dividends can be paid to shareholders.
If the director has financed the company in some way – for example lending the company money to buy a property or supporting the trade in the early years – this ‘loan’ of cash can be repaid from the company, usually with no tax implications.
A director can also be paid a salary from the company, and usually a mix of salary and dividends gives rise to the most tax efficient profit extraction solution. Salaries, declared through monthly RTI submissions, are not dependant on positive reserves. However, as directors’ salaries are an expense to the business, they will decrease profits/increase losses and therefore reduce available reserves.
Dividends currently carry a lower tax rate than salary payments, but they’re not deductible for Corporation Tax. It’s also important to carefully plan dividends as the tax year they fall into will determine the timing and amount of income tax payable.
With potential tax increases on the horizon in the Spring budget, a strategy could be to declare additional dividends early at the lower tax rate to build up a Director’s Loan Account balance to draw on later down the line.
A further method of remuneration is company pension contributions which are deductible for Corporation Tax and offer tax free growth. Although not immediately available as cash in hand, they can be a tax efficient method of profit extraction. We have a team within Old Mill that can assist with company pensions.
Remuneration planning can be complicated with cash flow, tax, and strategic issues to consider as well as your personal income needs and goals, so it’s definitely worth putting some thought to.
For further information on extracting profits from your business please get in touch with your Old Mill adviser or click here.