Business Matters – Issue 5

Subscribe

Entrepreneurs

Are you one ride away from the tax year-end finish line?

Making sense of your year-end

Getting your company pension contributions in shape

Talking tax

Your tax year-end checklist

(Don’t) join the club

How the humble pension can save you from the dreaded 60% tax rate

Eyes on your ISAs

How using your allowance now can improve your future

Entrepreneurs: Are you one ride away from the tax year-end finish line?

The tax year-end can bring its own unique challenges for small-business owners, so seize the moment and take the time to reassess your tax affairs to ensure you’re making the most of your allowances.

Understanding what your business needs to do at this crucial time can help you comfortably ride out the end of this tax year, arriving well prepared for the next one. Read on to discover just some of the available options.

Be your own boss? Have a better work-life balance? Be in control of your work schedule? Have the opportunity to follow your heart’s desire? These are just some of the reasons why you might choose to become a small-business owner.

You may have also taken that decision because it’s the “done thing” in your industry, or because you’ve had no other option – for example, you were made redundant. Either way, whatever the motives for going solo, you will be only too aware of how challenging the past year has been for you and your fellow entrepreneurs.

Depending on what business you’re in, the pandemic may have either hampered or facilitated growth.

“It’s tested products, services, abilities, motivation and resolve, before you even consider the personal impact,” notes Melloney Underhill, Marketing Planning & Analytics Manager at St. James’s Place Wealth Management.

Time to refocus

It’s highly likely that you will need to reassess your tax affairs if the coronavirus has impacted your business’s finances at all this past year.

“You might have been doing your accounts for the past five or 10 years without much really changing,” says Underhill. “This year is likely to be different, so you can’t simply repeat what you did last time.”

We may not be out of the woods yet, but the impending tax year-end is a timely opportunity to optimise your earnings and minimise some of the pressures you face.

Ways and means

If your income has increased, there are ways of either reducing or avoiding the potential tax implications. If you’re a director or owner of a limited company, for example, and you’ve made a profit during this tax year, dividend payments can be made to cut your tax bill.

The dividend allowance currently stands at £2,000, and you don’t have to pay tax on any dividend income within this limit. Any that exceeds £2,000 and remains within the basic-rate band is taxed at 7.5%, with no employee or employer national insurance contributions.

Dividends within the higher-rate or additional-rate bands are taxed at 32.5% and 38.1% respectively. Your personal allowance also needs to be accounted for, which is £12,500 for the 2020/21 tax year.

Options, options

Whether your business has been significantly affected during the pandemic or not, another helpful option is the use of annual pension allowances.

The pension carry-forward rules mean you can claim unused annual allowances from the three previous tax years, thereby maximising your pension contributions in the current tax year. Likewise, if you don’t envisage using all your allowance in the 2020-21 tax year, you could carry forward any unused allowance from this year to make sure that you take advantage of it over the following three tax years, as opposed to forfeiting the allowance entirely.

Companies whose earnings change significantly from year to year may find this particularly useful. Simon Martin, Chartered Financial Planner at St. James’s Place Wealth Management, comments:

“For a director of a limited company, making a pension contribution for the current tax year and carrying forward unused allowances from the three previous tax years will usually be very tax-efficient.

“Assuming the contribution meets the ‘wholly and exclusively’ rule [whereby employer contributions are deductible as an expense provided that they are incurred wholly and exclusively for the purposes of the employer’s trade or profession], the company will receive corporation tax relief on the contribution. As the contribution is made by the business, it is not dependent upon the salary received by the director.”

Pensions provide diversification for business owners because they can be invested in different companies, industries and geographies – yet another benefit to be had.

Complete certainty

Be mindful of the fact that some of these actions are not necessarily straightforward, as there can be small but potentially crucial nuances in the rules because they relate to different business types. In these uncertain times, it can also be all too easy to miss certain possibilities and opportunities to relieve your tax burden.

If there’s one way of being certain that you’re maximising your tax allowances, consulting a professional financial adviser does precisely that. They can help you optimise any money coming into your business and soften the blow of any losses you’ve suffered to date.

“As part of an effective remuneration strategy, ensuring that all the available allowances and exemptions are used is an important part of reaching your goals,” remarks Martin.

Here at Wellesley, we can also incorporate your tax situation into a broader, long-term financial plan, ensuring that, in spite of the current challenges, you still have the best chance of keeping momentum and moving your business in the right direction in 2021.

For a no-obligation chat, please get in touch on 01444 244551, and we’ll make sure you’re all kitted out to comfortably ride out the end of this tax year.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation and reliefs from taxation can change at any time. Tax relief is dependent on individual circumstances.

Making sense of your year-end: Getting your company pension contributions in shape

While a business’s accounting year-end can fall at any time, it makes sense to look at your taxation planning throughout the year – and there’s no time like the present to check in! Here, we focus on how pension contributions can help minimise your Corporation Tax liability.

It’s a good idea to regularly review your company’s tax position throughout the year, especially in light of the impact of external factors such as the COVID-19 pandemic. Another factor to keep a close eye on is the ever-changing tax legislation, as this can vastly change your tax liability. If your company accounting year-end is on the horizon, why not take some time to look at how you can reduce your Corporation Tax bill?

How?

One way to do so is by utilising your company pension contributions, as employer contributions are taken from your business’s pre-tax earnings, so they can be a tax-efficient way to extract value from the company. Not to mention that it will also help you and your employees build up a nest egg for the future – win, win!

It’s also worth noting that pension contributions may also be preferable to the payment of salary or bonus due to the NI saving (as employer pension contributions are exempt from employer NI), particularly where the employee would have used that money to fund personal contributions to a pension scheme.

When?

Remember that company pension contributions are relieved in accordance with the accounting year in which they are paid, not the tax year. So, if you’re planning for the end of your accounting period, the first thing you need to do is decide whether to make your pension contributions in the current accounting period or a later one.

If you want the contribution to be deducted in this year’s accounts, you must pay it before or on the last day of the current accounting period. It’s not possible to pay the contribution in one accounting year and have it deducted in the accounts of a different year. (However, if the pension contribution creates or enhances a loss, that loss can be carried forward and offset against profits of a later year.)

In most cases, employers should not have any issues obtaining a deduction for Corporation Tax purposes for all employer pension contributions. HMRC’s Business Income Manual confirms that ‘a pension payment by an employer is normally wholly and exclusively for the purposes of its trade.’

As we mentioned earlier, accounting periods don’t need to follow the ‘financial year’. So, for example, for a company with a 30th April 2021 accounting year-end, a company pension contribution must be paid on or before 30th April 2021 to reduce the company’s tax bill for that accounting year. A company pension contribution paid a day later, on 1st May 2021, wouldn’t be relieved until the company pays its tax bill for the accounting year ended 30th April 2022 – i.e. a year later!

The rate of Corporation Tax relief depends on the financial years covered by the accounting period. As any change to Corporation Tax rates will usually be applied from 1st April, Corporation Tax calculations can sometimes be complicated.

Quarterly payments

If you class yourself as a ‘large’ or ‘very large’ company, you’ll pay your Corporation Tax in quarterly instalments, but they can still be used to reduce your estimated tax liability – and the relief is potentially available much earlier.

Definition of a ‘very large’ company

  • Taxable profits of £20m or more for a 12-month accounting period
  • For groups, the £20m threshold is divided by the number of “related 51% group companies”: for these purposes, all active companies in the group are counted – including companies outside the UK
  • The threshold is reduced proportionately if the period is less than 12 months, although there is a de-minimis limit of a £10,000 tax liability. Below this amount, a company will not be treated as ‘very large’.

Definition of a ‘large’ company

  • For this purpose, where the profits for two consecutive 12-month periods are more than £1.5m but do not exceed £20m
  • The thresholds are apportioned between 51% group companies and time apportioned where the period is not 12 months.

Quarterly payment dates

The quarterly payment dates for ‘large’ companies are on the 14th day in the seventh and tenth month of the accounting period and the first and fourth month of the following period:

  1. 14th day of seventh month of the accounting period
  2. 14th day of tenth month of the accounting period
  3. 14th day of first month of the following accounting period
  4. 14th day of fourth month of the following accounting period.

The payment dates for ‘very large’ companies have been brought forward, for accounting periods beginning on or after 1 April 2019, so that the new timetable for these companies is:

  1. 14th day of third month of the accounting period
  2. 14th day of sixth month of the accounting period
  3. 14th day of ninth month of the accounting period
  4. 14th day of twelfth month of the accounting period.

For short periods of account, there are special rules to ensure that any ‘final’ instalment payment always falls within the accounting period. The balancing payment date for all Corporation Tax remains nine months and one day after the end of the accounting period (the only payment date for ‘small’ companies).

Note that under transitional rules, companies that qualify as ‘very large’ will have needed to make an additional payment in the first quarter of adopting the new rules.

A company pension contribution could be used to reduce the estimated tax liability calculated for the purposes of quarterly payments. Where a company is paying its corporation tax by quarterly instalments, the effective date of relief for a company pension contribution could be much earlier than would otherwise be the case.

Example

Company A Ltd.’s taxable profit for the accounting periods ended 30th June 2020 and 2021 is £2m and £2.1m respectively. Company A Ltd. is a ‘large’ company, so its Corporation Tax payments are due in the seventh and tenth month of the accounting period and the first and fourth month of the following period. A £300,000 company pension contribution made between 1st July 2020 and 30th June 2021 would therefore effectively be relieved as follows:

  1. £14,250 14th January 2021
  2. £14,250 14th April 2021
  3. £14,250 14th July 2021
  4. £14,250 14th October 2021.

Making 2021 a less taxing year

As we have seen, it’s a good opportunity to check in with your company’s tax position and how employer pension contributions – especially if (personal) pensions are already on your mind due to the end of the tax year on 5th April.

But Pensions and Corporation Tax are complicated subjects, so to make sure you are following the rules and for advice on how you can effectively utilise employer pension contributions, taking expert advice is a must. The government is currently reviewing the whole area of how cash retained in a company should be taxed, and we may see substantial changes announced in this area in the future. Here at Wellesley, we can help you stay ahead of the game!

Sources:

Related links:

Talking tax: Your tax year-end checklist

As the end of the tax year approaches, this is the time to make sure you have done everything you can to make the best use of tax-free allowances.

After a turbulent 2020, it’s easy to see how business owners who are laser-focused on their company might not be paying enough attention to their own finances. But utilising these valuable reliefs and allowances can help to create long-term financial security for you and your family – and now’s the perfect time to do so.

To help, we’ve delved into the various allowances in more detail to help you make the most of your tax-saving opportunities before 5th April.

Click the link below to download your tax year-end checklist:

Click to download

If you have a question about the end of the tax year, please contact us today!

(Don’t) join the club: How the humble pension can save you from the dreaded 60% tax rate

While earning a £100,000 salary is surely cause for celebration, your glass of bubbly might well come with a bitter aftertaste of tax. Why? Because, by joining this milestone salary, you’re also joining the dreaded 60% Club.

Here’s how you can avoid this “exclusive” group, while still enjoying the benefits of your six-figure salary. With the end of the tax year approaching, you might make a difference sooner than you think!

The UK tax system is full of quirks – a sentiment that’s epitomised by the 60% tax bracket. The FT calls this secret band “the six-figure curse” – but how does it work? And how can you avoid it?

Avoiding the 60% tax trap

But wait, a 60% tax band doesn’t appear on HMRC’s listing, you may say. But trust us, it’s there – if unofficially!

Essentially, it’s a calculation of how much you end up paying when you lose your personal allowance once it’s deducted. The personal allowance1 currently stands at £12,500 for the 2020-21 tax year, having seen significant increases in recent years. The threshold for the loss of this allowance, however, has remained fixed at £100,000 since its introduction in 2010.

This means the band at which you pay an extra 20% of tax on top of the 40% for this income band (and therefore an effective rate of 60%) has grown substantially to £25,000. For each £2 of additional income above £100,000 the personal allowance reduces by £1. At income levels above £125,000 the personal allowance is zero.

You also won’t be eligible for the 45% tax band until you earn over £150,000 – so, it’s an oddity of the tax system to have marginal income tax rates of 20%, 40%, then 60%, then falling back to 40% before finally rising to 45% again at £150,000.

The power of the pension

At Wellesley, we always laud pension contributions as a valuable tool in improving your tax efficiency, and they really come into their own when helping you avoid the spectre of the 60% tax.

Personal contributions to both occupational schemes and personal pensions schemes can reduce the adjusted net income figure and can therefore restore some or all of the personal allowance, as seen in the example below:

Example 1

George has an income of £125,000 in 2019/20. A net (relief at source) pension contribution of £20,000 receives £5,000 relief at source. His net income falls by £10,000 in return for a pension contribution of £25,000 – an effective rate of tax relief of 60%.

  Difference when making a personal pension contribution

 

Income £125,000 £125,000
Personal allowance £0 £12,500
National Insurance £6,464 £6,464
Tax £42,500 £32,500
Net personal pension contribution £0 £20,000
Net income £76,036 £66,036
Effective tax relief 60%

The benefits of salary sacrifice

Another way of mitigating the impact of tax is salary sacrifice – indeed, you can receive even greater benefits!

As well as reducing your taxable income, a reduction in salary will also lower both the employee and employer National Insurance (NI) contributions. Where the employer is willing to reinvest their NI savings, the effective rates of tax relief can be up to 67% – as seen in the example below.

Example 2

If George were instead able to make his pension contribution via salary sacrifice for a net cost of just £9,500, an employer contribution could be made of £28,450.

Difference when using salary sacrifice and employer contribution
Income £125,000 £100,000
Personal allowance £0 £12,500
National Insurance £6,464 £5,964
Tax £42,500 £27,500
Net income £76,036 £66,536
Employer contribution £28,450
Effective tax relief   66.61%

It’s important to note, though, that in terms of the tapered annual allowance, while any personal contributions via relief-at-source schemes will reduce your Threshold Income, using salary sacrifice will not. Any new salary sacrifice arrangements will be added back to your other income.

 (Don’t) join the club

To conclude, then, while joining an exclusive club would usually be an honour, the 60% Club is one to avoid, if possible. With careful planning, you can continue to enjoy the benefits of your £100,000 salary, without the taxman taking such a large cut.

While the 60% tax trap doesn’t directly affect many people, it’s still worth knowing about, because it’s the perfect example of how tax ‘sinkholes’ can appear by surprise and in different places, catching you unawares. At Wellesley, our experienced advisers can help you swerve around any sudden sinkholes or mitigate the effects of those that can’t be avoided.

And, with the end of the tax year just around the corner, don’t forget to take advantage of your pension allowance – you can also carry forward unused allowances from the past three tax years. For advice on the options available to you, please contact Wellesley today.

The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations.

Appendix:

1 Understanding the personal allowance

The personal allowance income limit is based on an individual’s adjusted net income. For those familiar with tapered annual allowance calculations, please note that this is quite different from the adjusted income figure used there.

However, adjusted net income involves the same first step, which is to calculate the individual’s total taxable income or ‘net income’ before the personal allowance. This includes income such as earnings, profits from self-employment, rental income and dividends and is after deductions for pension contributions made gross, such as occupational pension contributions deducted from salary before tax is calculated, or an AVC paid gross to an occupational scheme.

From the ‘net income’ figure, two important deductions are made to arrive at ‘adjusted net income’. These are the grossed-up value of any relief at source pension contributions and any charitable donations made by Gift Aid.

Eyes on your ISAs: How using your allowance now can improve your future

With one month to go until the end of the tax year, now’s the time to make the most of the tax breaks that are available. And, as the below infographic shows, ISAs are a smart way to reduce the tax you pay when taking an income in retirement.

An ISA shelters your money from further liability to Income Tax or Capital Gains Tax, which can help to give your savings a significant boost over the long term. So, if ISAs are part of your long-term plan, it’s important to invest your allowances wisely to make the most of the tax benefits.

Don’t forget that, in the current tax year, the ISA allowance is £20,000 – and the annual ISA limit is per person; so, if you have a spouse or partner, you can each have an ISA and pay in anything up to that amount, thus effectively doubling the limit to £40,000.

Remember: you can’t carry forward your allowance, so use it or lose it!