Many tax advisers and accountants will be familiar with their clients asking how they can make their firm more tax efficient. It is a very valid question: one management should not hesitate to ask.
The question can be asked at any time in the tax year, but may be best following a discussion of the organisation's latest set of accounts. At that point, the adviser will have all the details of the firm fresh in their mind and so it will just be a case of taking a step back to look at the wider picture.
It should be remembered that tax efficiency is not just about minimising immediate liabilities to income tax or corporation tax – for those looking to retire or sell up in the next 5 years, tax efficiency should also include consideration of taxes such as Capital Gains Tax and Inheritance Tax, where there are reliefs available to owners.
Structure
The biggest impact on tax efficiency, and therefore the least likely to be a quick fix, will be the business structure. There are four main options: sole trader; partnership; limited liability partnership (LLP); or a company. The choice of structure drives which of the direct taxes the business is liable to, with sole traders, partnerships and LLP members paying income tax and National Insurance on their profits, and companies pay corporation tax. Although corporation tax rates are lower than the highest rates of income tax (2022/23 – up to 45% or 46% in Scotland), a company director-shareholder will pay a second layer of tax in the form of income tax (and potentially National Insurance) on any salary or dividends that they take out of the business.
Traditionally, incorporation has always been seen as the most tax efficient structure as it allows owner–managers to control how much income they take from the business and how (sole traders and partners are assessable on all of their profits, regardless of whether or not they take them out of the business), and it reduces National Insurance bills. Incorporation also brings non-tax benefits, such as limited liability, although it is less flexible for sharing profits between partners and comes with extra administrative burdens arising from running a company (such as filing accounts each year with Companies House). However, in the past decade, the tax savings for incorporation have narrowed as taxes on dividends have been increased, and corporation tax is to increase from 19% to 25% from April 2023. Unincorporated businesses therefore need to crunch the numbers before taking this step. While there are tax reliefs to support incorporation, there are no reliefs for going the other way.
On incorporation, there may also be goodwill, which could be sold to the business creating a loan account on which the director can draw. While this would be subject to Capital Gains Tax upfront, typically at 20%, it can still be a tax efficient way to get value out of the company in the future.
If there are potential savings for income tax and National Insurance, the final step is to consider the effect of incorporation in the long-term, particularly on Inheritance Tax or Capital Gains Tax. Changing the business structure will have a knock-on effect on both, particularly if the firm owns rather than rents premises, and care needs to be taken to understand how changes might affect valuable reliefs such as Business Asset Disposal Relief (relevant for Capital Gains Tax on a business sale) or Business Property Relief (for Inheritance Tax purposes).
The super-deduction
As evidence of how structure can affect the tax position, this relief is only available to incorporated businesses. Where a business purchases assets, relief is given through a system of capital allowances. Until 31 March 2023, there is a ‘super-deduction’ available to give enhanced relief on the cost of plant and machinery purchased by a company. For every £100 spent on equipment before that date, a company can claim £130 in tax relief. The only caveat to claiming this would be if the business is intending to dispose of the asset for value after a couple of years, as there are mechanisms to claw this additional relief back in these circumstances.
Go electric
If the business provides cars to staff which they can also use privately, it might be worth looking at whether replacing them with an electric alternative could be practical. There are a number of timelimited tax benefits for electric cars, including very low benefit in kind charge for private use, which can be a fraction of the cost of providing a diesel or petrol car, plus 100% capital allowances for electric cars purchased before 31 March 2025.
Keep records and receipts
Although never a very exciting recommendation, it is important not to overlook simple things – such as ensuring all relevant business expenses are being recorded and claimed, and that copies of receipts are kept to evidence expenditure. This is important, not just for direct taxes like income tax/corporation tax, but also for Value Added Tax (VAT) where HM Revenue & Customs (HMRC) can disallow VAT claims if the trader does not have supporting evidence for the claim.
Receipts are not the only information relevant to the business. For sole traders or partners who use their personal vehicle for business travel, then it is common to claim a percentage of the running costs for the year against the business profits. In order to justify the percentage of business use, it is a good idea for them to keep a log of business and private mileage for a few weeks each year to support these claims.
Get things right
Tax efficiency is not purely about trying to pay less tax, it is also about paying the right amount of tax. HMRC enquiries can be stressful and expensive, and therefore it pays to be the right side of the law. If in doubt, owners should take reputable advice – there is a lot of good, if basic, advice to common queries on GOV.UK. HMRC also provide webinars (called Talking Points) on specific aspects of tax, as well as detailed guides for employers on getting payroll taxes and the National Living/Minimum Wage correct.
Tax efficient perks for staff
Staff, as a general rule, will be taxable not just on their salary, but also on any benefits that they are provided, such as medical insurance, company car etc. (see electric cars). There are also special rules introduced in 2017 that mean that if the employer offers an employee a choice between salary or a benefit, they will be taxed on whichever is the higher – the salary forgone or the value of the benefit. However, despite the tightening of rules in recent years there remain various tax-efficient ways of providing benefits to staff including:
- ►Mobile phones: a single mobile phone supplied to an employee is an exempt benefit in kind, even if the employee uses it privately, provided that the contract for the phone is between the business and the supplier
- ►Homeworking allowance: this is unlikely to be relevant for all staff, but if the business has administrative staff who work from home some or all of the time, they can be paid up to £6/week or £26/month tax-free as reimbursement for their additional costs of heating or lighting at home
- ►Staff parties: an annual event for staff (such as a Christmas party or annual summer ball) costing no more than £150 per head does not create a benefit in kind for staff and the costs will be tax deductible for the employer.
» For any business owner, tax efficiency is not just about the business itself, but also their personal affairs, as the two are often inextricably linked «
Salary sacrifice for pension contributions
Salary sacrifice involves an employee agreeing to give up their salary in exchange for a benefit – usually one that is taxed at lower rates than a salary. Although rule changes in 2017, as noted above, limited the number of situations in which salary sacrifice is tax-efficient, there are still some benefits to be had, particularly around pensions.
If an employee is making contributions themselves, but agrees instead to accept a lower salary in exchange for the employer making the contributions on their behalf, there can be tax savings for both parties. The employee pays less tax as their salary has been reduced, and the employer benefits from lower employers’ National Insurance contributions – all while pension contributions remain the same.
This requires a formal change to the employee’s contract to which they must consent. An employee can’t sacrifice their salary below the minimum wage so it may not work for all staff, but properly implemented this can be beneficial to all parties.
Military veterans
Where an employer hires a member of staff into their first civilian role since leaving military service, then it will not have to pay any additional secondary National Insurance contributions for the first 12 months. This measure was introduced in April 2021 and is specifically intended to support the employment of military veterans.
Personal planning
Finally, for any business owner, tax efficiency is not just about the business itself but also their personal affairs, as the two are often inextricably linked. It is helpful, therefore, to consider both together. This might be looking to run the owner’s electric car through the business, reviewing the amount and timing of pension contributions in the run up to the tax year end, or considering if the work or involvement of a lower-earning spouse in the business would merit a salary. Major changes, such as buying or selling a firm, or retiring, should be flagged well in advance to maximise the available reliefs.
Summary
Tax is an obligation upon us all, but it needn’t be taxing. That said, to get the best out of the system, forethought and good independent advice are essential.