Case study – extracting business profits for remuneration – Answers
Brian and Beryl Blake, aged 72 and 77 respectively, are seeking your advice on winding down their business interests, by passing them on to their son Robert who is 45 and his two sons Sam and Jamie both in their 20s. They all work in the family business.
Brian and Beryl own 80% of the issued share capital of B & B Blake and Sons Farming Ltd and the remaining 20% is held by other family members. The business has an asset value of £2.8 million which, apart from long-term cash reserves of £180,000, is made up of farming land and other farming assets. Brian and Beryl live in a property owned by the farming company for which they pay a commercial rent. The company typically makes profits in the region of £150,000 per annum prior to Brian and Beryl’s remuneration.
Brian and Beryl have decided to give their entire share capital in the company to Robert. However they want to first extract the £180,000 cash which they intend spending on leisure activities over the duration of their remaining lives.
Brian, Beryl and Robert run a separate campsite business as a partnership which generates net profits each year in the region of £30,000 per person.
Brian receives an annuity of £58,000 a year and Beryl receives £20,000 from crystallised pension plans and they each collect a full State Pension. You are advising Brian on certain tax planning matters.
Brian is seeking advice on his plan to extract £180,000 from the business for leisure spending, which is likely to involve the purchase of a luxury car costing £105,000. He tells you that it is important that whatever extraction method he uses, the net cost to the company, taking into account the cash he takes and any ancillary Tax and National Insurance costs or savings, must be exactly £180,000. Brian has not received any other taxable remuneration from the company in the current tax year 2013/14.
(i) Calculate, the total salary expense the company could allocate for Brian, to include the £180,000 and the resultant Corporation Tax saving created by a salary payment.
Answer:
Gross salary to produce net of Corporation Tax cost of £180,000 is £180,000 ÷ (100% – 20%) = £225,000.
(ii) Using the answer you identified in (i) above, calculate, the net sum Brian will obtain if he receives a salary payment as a means of extracting money. Your answer must take account of the employer’s National Insurance liability.
Answer:
Employer’s National Insurance (NI) will be 13.8% of salary in excess of £148 per week.
Salary subject to employer’s NI, therefore, £225,000 – (52 x 148) = £217,304.
Net of NI amount, therefore £217,304 ÷ (100% + 13.8%) = £190,952. £190,952 + (52 x 148) = £198,648 gross pay.
Brian is over State Retirement Age so no employee NI to pay.
Brian currently pays tax at 40%.
Profits + Annuity + State pension = £93,727 + Earnings of £198,648 = £292,375
Remaining band at 40%: £150k – £93,727 = £56,273 @ 40% = £22,509.
Remaining income at 45%: £198,648 – £56,273 = £142,375 @ 45% = £64,068.
Net income = £198,648 – (£22,509 + £64,068) = £112,071.
(iii) Calculate and provide explanations of the steps where necessary, the net sum Brian will obtain if he receives a dividend payment as a means of extracting the £180,000.
Answer:
Dividend payment is neutral for the company as there is no Corporation Tax or NI considerations.
It carries a notional 10% tax credit to cover basic rate liability.
Brian will have a liability to higher-rate tax on the grossed up dividend.
£180,000 ÷ (100% – 10%) = £200,000
£150,000 – £93,727 = £56,272 @ 22.5% = £12,661
£143,728 @ 27.5% = £39,525
Net sum: £180,000 – £52,186 = £127,814.
(iv) Explain the checks you need to make before recommending Brian to draw a dividend.
Answer:
Check that Brian and Beryl’s shares carry dividend rights and who holds the other 25% shares and whether they agree to waive their dividend rights.
Does the company have sufficient reserves to pay the dividend (including those waived?)
