Tax planning - company profits or director's salary?

Brendan Burgess

Brendan Burgess

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This is my understanding of the rules and proper strategy. Pay an accountant for tax advice before taking any decisions based on this information.

Year end 31 December 2004

Profit before paying anything to director 50k
Salary already paid during the year 40k
Profit per draft accounts: 10k

If you leave the profit in the company...
Corporation Tax on profit at 12.5% 1250
Amount left in the company: 8750

Pay this as salary the following year
Income tax and PRSI at 47% 4112
Net pay into your hand 4637.50

Effective tax rate on 10k profits 53%

So you are better off paying the 10k as profits in 2004
You can pay this via the PAYE system in 2004 if you know your profits.

Or you can accrue it in the accounts as long as you pay it by the end of June 2005.

To make matters worse...
If you leave the profits in the company and it is a service company, you will pay a further surcharge tax on undistributed professional income.

Paying dividends is very tax inefficient for various reasons.

Let's say you want to keep some profits in the company in case of a poor 2005...

Let's say that the profit before paying anything to the director is nil in 2005.

You can leave the 10k profit in the accounts for 2004 and pay 12.5% Corporation Tax on it. You can pay yourself 10k salary in 2005 which will be subject to little or no tax.

You will have made a loss for Corporation Tax purposes in 2005, which you can carry back against the profit for 2004 and get a refund of the Corporation Tax paid.

You may also want to leave money in the company for capital expenditure
If the company needs a lot of capital, then just leave the money in the company and pay the 12.5% corporation tax.

If it's a small amount of money, you might consider paying all your profits as salary and lending the money to the company for the capital expenditure.

Consider making a pension contribution
If you expect very big profits in 2004 and don't need the money, your company may make a contribution to your pension scheme before the year-end. I don't think it can be paid in 2005 and backdated against 2004 profits.
 
Brendan said:
If you leave the profit in the company...
Corporation Tax on profit at 12.5% 1250
Amount left in the company: 8750

Pay this as salary the following year
Income tax and PRSI at 47% 4112
Net pay into your hand 4637.50

Effective tax rate on 10k profits 53%

So you are better off paying the 10k as profits in 2004
Click to expand...


Loss relief can be used to offset a current year loss against profits of the preceding year. Hence the double tax charge indicated above will not always apply. For example if the payment of additional salary generates a tax loss in year 2, the Corporation Tax bill in year 1 is recovered.

The surcharge on undistributed service company income is applied very narrowly in practice to the point that it is irrelevant in almost all scenarios where the taxpayers are properly advised.

If it's a small amount of money, you might consider paying all your profits as salary and lending the money to the company for the capital expenditure
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I would regard this as very poor advice.
 
Loss relief can be used to offset a current year loss against profits of the preceding year. Hence the double tax charge indicated above will not always apply. For example if the payment of additional salary generates a tax loss in year 2, the Corporation Tax bill in year 1 is recovered.
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Hi Ubi

Is that not clear from my explanation? In the bit under: Let's say you want to keep some profits in the company in case of a poor 2005...
If it's a small amount of money, you might consider paying all your profits as salary and lending the money to the company for the capital expenditure.
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I think it's important to stress that I am not advising this in the same way as I advised against leaving profits in the company. I am saying that you "might consider". I think that you should consider it. If you do the calculations or get your accountant to do the calculations, you will probably find that it is not worthwhile. But I don't think it's bad advice to consider something.

Brendan
 
Hi Brendan

Point taken. However I still can't see how it could be beneficial tax-wise for a company director to pay themselves additional salary and lend the net proceeds back to the company. There might be a benefit in inflating salary in this way in order to secure a higher mortgage, or it might be necessary in order to sort out an existing directors loan problem in the company but otherwise I can't see any tax benefit.
 
Hi Ubi

It's a pretty arcane point, so I think it would distract from the key strategic issues on directors' salaries vs. profits. I have emailed you my thoughts on the issue.

Brendan
 
So if I have a limited company whose business is professional services and I want to retain profits to invest in equities after paying corporation tax it is not a viable option?
 
DirtyH2O said:
So if I have a limited company whose business is professional services and I want to retain profits to invest in equities after paying corporation tax it is not a viable option?
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Just pay the corporation tax, its only 12.5% of taxable income, assuming all trading income.

I note you carry on a profession, are you familiar with the surcharge on undistibuted service income of a close company (a co with less than 5 shareholders or directors who act as shareholders), it serves to ensure any post tax retained profits are taxed at a further surcharge at 7.5%
 
I was. The earlier quote

The surcharge on undistributed service company income is applied very narrowly in practice to the point that it is irrelevant in almost all scenarios where the taxpayers are properly advised.

was the opposite to the advice I received from an accountant. I was interested in retaining profits and only paying what I needed. I already have after tax funds available to me so I don't have a need for a high salary. i am not sure which advice is correct. So if I meet the definition of a close company I am liable for the 7.5% tax. I had abandoned the idea of retaining profits in the company due to this factor. It's not much of an encouragement to grow a company should I wish to diversify into different business areas.
 
DirtyH2O said:
I was. The earlier quote

The surcharge on undistributed service company income is applied very narrowly in practice to the point that it is irrelevant in almost all scenarios where the taxpayers are properly advised.

was the opposite to the advice I received from an accountant. I was interested in retaining profits and only paying what I needed. I already have after tax funds available to me so I don't have a need for a high salary. i am not sure which advice is correct.
Click to expand...

The advice above and your accountant's advice are not opposites. The main reason the surcharge on undistributed service company income causes very few problems in practice is because directors/shareholders of small companies, when properly advised, will avoid having excessive amounts of retained income sitting within service companies and more generally will avoid having rental/investment assets within any form of limited company structure. It makes no sense to have assets growing within a limited company when it is much cheaper tax-wise to own these in the name of the shareholder.
 
Thanks for the advice. It seems clear that the best route is to take the money out as salary or else incur additional taxes and further complications in the future.
 
From :


(4)
(a) Where for an accounting period of a service company the aggregate of–


[ (i) the distributable estate and investment income, and


(ii) 50 per cent of the distributable trading income, ] 1


If say a company has no distributable estate and investment income and pays it's shareholders/directors 50% of its trading income in salaries, then I presume the amount retained is not subject to this undistributed services income surcharge? Can anyone please clarify this?

Thanks,

F.
 
Salaries don't count as a distribution. You must make a distribution i.e. dividends or pay the surcharge.

OR

Ensure you have insufficient distirbutable reserves to make the distribution. Remember, to make a distribution out of insufficient reserves is illegal (company law), and you can't be doing something illegal so tax law excuses the surcharge in these circumstances.

So what I am saying - when the time comes to calculate and pay the surcharge i.e. 18 months after the year end, ensure your reserves and insufficent.
 
I know this is an old enough thread but there are a few recent posts so I thought i'd add something to it.

In a lot of cases directors extract profit (over and above what they require to live on) so that the company breaks even. They may even leave this to be drawn at a future date as a directors loan.

However consideration should be given to a more long term approach - leaving the profit in and building up the reserves and availing of retirement relief via a share buy back when hitting the age of 55. This can be an excellent way of getting money out of a company tax free (€750k per director assuming all conditions satisfied and no other life time use of limit).

The main caveat is that this is a relief that might be downgraded significantly from 2012 onwards.
 
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kennyb3 said:
I know this is an old enough thread but there are a few recent posts so I thought i'd add something to it.

In a lot of cases directors extract profit (over and above what they require to live on) so that the company breaks even. They may even leave this to be drawn at a future date as a directors loan.

However consideration should be given to a more long term approach - leaving the profit in and building up the reserves and availing of retirement relief via a share buy back when hitting the age of 55. This can be an excellent way of getting money out of a company tax free (€750k per director assuming all conditions satisfied and no other life time use of limit).

The only caveat is that this is a relief that might be downgraded significantly from 2012 onwards.
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That isn't the only caveat.

It's a mistake to allow tax to drive the agenda. There may also be commercial reasons for not allowing money to accumulate in a company.

And as you've alluded to, the Commission for Taxation recommended reform in the retirement relief/business property relief areas, so long term planning in relation to these reliefs may be futile.
 
Gekko said:
That isn't the only caveat.

It's a mistake to allow tax to drive the agenda. There may also be commercial reasons for not allowing money to accumulate in a company..
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Obviously but this is a taxation forum so obviously the taxation rather than commercial aspect is focused upon.

Gekko said:
And as you've alluded to, the Commission for Taxation recommended reform in the retirement relief/business property relief areas, so long term planning in relation to these reliefs may be futile.
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It's still worth considering if you are in your 50's. Its unlikely to go from €750k to nil in 2012.
 
Just wondering how the idea that the surplus profit left in the company should be taken out as salary at 47 percent tax is being promoted so readily ?
Are we saying that there isn't a way to save any further tax on this profit?
 
I haven't had to visit this issue for some years, but I have just been asked my opinion by a friend who is a director of a company.

He has been told by his accountant that he must pay all his profits as salaries for 2013 in the month of December 2013. The accountant dismissed the idea that the salaries could be accrued and paid later.

The particular business is tight from a cash point of view and the directors have lent money to the company. They will be making cash flow worse by paying themselves salaries in December because they will have to pay around 50% of it in income tax and prsi within the next few days.

I have advised them to stop paying themselves salaries and repay the loans from the directors instead.

They need to make a decision in June 2014 and set the accrual at that stage.
 
Brendan Burgess said:
He has been told by his accountant that he must pay all his profits as salaries for 2013 in the month of December 2013. The accountant dismissed the idea that the salaries could be accrued and paid later.
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Seems strange but we don't know the context and there may be issues there that we're not aware of.
 
Brendan Burgess said:
I haven't had to visit this issue for some years, but I have just been asked my opinion by a friend who is a director of a company.

He has been told by his accountant that he must pay all his profits as salaries for 2013 in the month of December 2013. The accountant dismissed the idea that the salaries could be accrued and paid later.

The particular business is tight from a cash point of view and the directors have lent money to the company. They will be making cash flow worse by paying themselves salaries in December because they will have to pay around 50% of it in income tax and prsi within the next few days.

I have advised them to stop paying themselves salaries and repay the loans from the directors instead.

They need to make a decision in June 2014 and set the accrual at that stage.
Click to expand...

Post isn't really clear. Is the company making profits but just short of cashflow on a short term basis?

If it's loss making - little point declaring salaries (dec 13 or june 2014), paying tax on same, only to be ploughing it back in (possibly never to be repaid).

Really you'd need to give a more rounded position of the company situation to get proper analysis.
 
Hi Kenny

The company is making healthy profits after paying fair salaries to the directors - probably in the order of €100,000.

But the working capital demands are high, so they would have to borrow from somewhere to pay the €100,000 in gross salaries in December. They have a big paye and prsi bill in January.

I have told them that they do not need to pay it until June 2014. In their accounts, they can accrue the salaries.

Brendan
 
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