Setting up a business is far from straightforward. As well as all the hard work and time it takes to build up and manage a profitable company, there is also a lot of risks for business owners. Once the business starts turning a profit, company directors should be rewarded and start turning their attention to ensuring the profit accruing within the business begins to filter into personal wealth. With the right financial planning advice, you can ensure your business is working for YOU.
How are Company Profits Taxed?
There is a 12.5% corporation tax which is applied to all ‘active’ income. This is the income generated from the day to day trading within the business.
There is a 25% corporation tax levied on any income for ‘non-active’ income. This can be income generated from rental properties or investments.
There is also a reduced 6.25% corporation tax relating to profits generated from a usable qualifying asset created from Research and Development (R&D) activities.
How are you taxed as a Director?
Any income you take from the company will be taxed at source under the PAYE system (income tax, PRSI & USC). A director is also noted as a ‘chargeable person’ for income tax purposes and is obliged to submit a director’s income tax return each year.
Directors must also comply with the ‘self-assessment’ regime which means they may be required to make payments on account to meet their preliminary tax requirements. If these payments are not made by the due date, the director will be exposed to ‘statutory interest’ which is calculated at a rate of approximately 8% per annum.
There are some exceptions to this rule. Non-proprietary directors (directors who own less than 15% of the share capital), as well as unpaid directors, are excluded from the obligation to file an annual income tax return.
Can you pay yourself through dividends?
Many directors pay themselves through dividends. A tax of 20% will be deducted at source, but you will be liable for further taxes if you are in the higher tax bracket. PRSI and USC are also due on the gross dividend and will be collected through the self-assessment system.
It may disadvantage the company by paying yourself in dividends, as no corporation tax relief will be available to the company, due to dividends being paid out after-tax profits. Also, the company will be required to pay ‘Dividend Withholding Tax’ at 20% on any dividend payment made.
Dividend payments are not included for pension funding calculations. They are also not taken into account for your years’ service either.
The more service you have in employment, the more pension funding you are permitted.
Transferring Company Profits into Pension
One of the most tax efficient ways to extract profit out of a business is by way of a company pension. Directors can avoid an immediate tax liability by transferring profits into a pension.
Tax relief for the company
Contributions made by the company into an Executive Pension can usually be offset against corporation tax, as these payments are deemed to be a legitimate business expense (subject to revenue limits).
Tax relief for the director
If accrued profits built up in the company are taken out as salary, the director will have an immediate Income Tax, USC and PRSI liability. If the proceeds are then made as contributions into a pension scheme, the contributions will receive tax relief and will be able to grow tax-free, until such a time when you decide to draw on this benefit. There is also no ‘benefit in kind’ charged on employer contributions.
What pension fund can I have?
Individuals have a maximum lifetime limit of €2 million to which they can fund their pension to, once they have the required salary and years’ service.
This amount can be funded by making a regular annual premium. The company can offset the full amount of the regular annual premium, assuming these are employer contributions.
Revenue also allows special contributions (single premiums) to be made into an executive pension in order for the individual to fund for the €2 million threshold. If the company has built up excess profits, and the special contribution is more than the regular premium, they can spread forward the relief over a number of trading years, potentially reducing the corporation tax in each of those years as well.
This allows companies to fund for ‘back service’, for those employees who had not received pension payments before. A scenario where this may occur is perhaps where the company was not previously in a financial position to make such contributions.
Example: Mary a company director maxing out pension contributions
Mary is 55 and has run her own business for 10 years and is currently drawing a salary of €100,000. Mary is hoping to retire in 10 years’ time (age 65). Her company is currently contributing €25,000 into an executive pension which has an overall value of €200,000.
The company is performing well and they have profits of €300,000 and this is expected to grow in the future.
Mary wants to fund for the €2 million threshold at her retirement age of 65, assuming a growth rate of 4.5%.
Option 1: The company could increase the annual regular premium to €113,500 per annum.
Option 2: The company could make a special contribution of €200,000 and then make annual contributions to €94,800
|Special Contribution||Regular Annual Premium|
If Mary decides to go with option 1, the company can offset the €113,500 annual regular premium contribution in the current trading year, reducing the corporation tax this trading year. This can be done every year the regular premium is paid.
If Mary decides to go with option 2, the company could offset the €94,800 annual regular premium in the current trading year, reducing the corporation tax this trading year. This can be done every year the regular premium is paid.
As well as this, as the ‘one off’ single premium special contribution is greater than the regular premium, the company can spread forward the relief for this contributions over a number of trading years, potentially reducing the corporation tax liability in future years.
Can my Spouse have a pension?
It would not be uncommon for many directors of small businesses to also have their spouses working in the business. These would range from active directors to part-time workers. The company can also put in place a spouse’s pension. With a part-time worker, it makes sense to fund for the max pension of 2/3rds final salary. The spouse needs to have a declared earned income within the business in order to qualify for pension funding.
Example: Mary’s husband John (55) is paid a salary of €20,000 per annum.
An executive pension could be put in place which attempts to fund for 66.6% of final salary (escalating @ 1.5% p.a. which would equate to €29,000 at age 65). We could also include a 100% spouses’ pension as a requirement. A pension fund of €500,000 would be required for this pension. Assuming John has no other retained pension benefits, the company could make contributions of €43K per annum which could be offset against the corporation tax liability.
It is worth noting that Revenue will want to ensure that a spouse is actually working in the business and is being paid a reasonable rate of pay for the work they are carrying out.
Funding for a Maximum Lump Sum
A director can also fund for a maximum tax-free lump sum of 150% of salary once they have more than 20 years’ service.
If a director has a salary of €100,000, they can fund for a pension pot of €150,000 (150% of salary). This will then be able to withdrawn as a tax-free lump sum.
The pension can be funded from company contributions which as previously explained will in turn reduce down the corporate tax liability.
Retirement Relief is also worth mentioning when speaking about extracting profit from a business as this might also give rise to crucial tax relief benefits when the day comes that you wish to dispose of the business and extract the value built up in it.
This relief applies where a person aged 55 or more disposes of a farm or business. This must be a qualifying asset.
There are two types of relief available.
- If you dispose of your business or farm to your child, then the gain is exempt. There is no limit on the value that may be passed to your child, however, there is a lifetime limit of €3 million where the disponer is aged 66 or over.
- If you dispose of your business or farm to any other person, the gain is exempt if the proceeds do not exceed €750,000. There is a lifetime limit of €500,000 if the disponer is aged 66 or over.
Retirement relief is subject to a “bona-fide commercial reasons” anti-avoidance test. This should be discussed as part of the overall retirement planning process and should form part of your estate planning.
This is a relief which was introduced to reduce the rate of CGT applicable when entrepreneurs sell their business. This is to encourage business development and to reward those who take risks in starting up a new venture.
The relief reduces the rate of CGT to 10% (reduced from a normal rate of 33%). This relief only applies to the first €1 million of gains.
There are a number of conditions that need to be met in order to qualify for this relief and it is important to consider the business structure to ensure that nothing precludes the eligibility of such relief. This can is a complicated area and tax advice should be sought before any major corporate restructures, incorporations or introspective transfers take place.
Do you want to find out more about extracting profit from your business?
Contact us if you would like to schedule a meeting where we can discuss the various options available to you and put a financial plan in place which ensures you are drawing income and wealth from your business effectively.