Running a property business through a limited company rather than as an unincorporated business may be an attractive proposition; at 19% the rate of corporation tax is lower than the basic rate of income tax and interest and financing costs are fully deductible in computing taxable profits. However, the tax bill on the company is not the end of the story – if profits are required outside the company, they will need to be extracted, and this may come at a further tax cost.
Take a salary
If your personal allowance has not been utilised elsewhere, it can be tax efficient to take a small salary. As long as the salary is at least equal to the lower earnings limit (set at £6,240 for 2021/22), paying a salary will ensure that the year is a qualifying year for state pension and contributory benefits purposes.
The optimal salary will depend on whether the employment allowance is available to shelter employer’s National Insurance contributions. Where the allowance is not available, as will be the case if the company has only one employee who is also a director, the optimal salary is equal to the primary threshold of £9,568. If the employment allowance is available, it is tax efficient to pay a higher salary equal to the personal allowance of £12,570.
Once a salary at the optimal level has been paid, it is more tax-efficient to take further profits as dividends, than to pay a higher salary. The dividends will be tax-free to the extent that they are covered by any unused personal allowance and the dividend allowance, which is set at £2,000 for 2021/22. Once the allowances have been used up, dividends are taxed at 7.5%, 32.5%, and 38.1% where they fall, respectively, in the basic rate, higher rate, and additional rate bands.
There are some rules which govern the payment of dividends. They can only be paid out of retained profits (on which corporation tax has already been paid) and must be paid in accordance with shareholdings (although the use of an alphabet share structure allows for flexibility).
Other options for extracting profits from the property company include the provision of benefits in kind, which can be tax-efficient where the benefit is exempt from tax and National Insurance, the payment of rent if the business is run from home, and making pension contributions on the director’s behalf.
Partner note: ITA 2007, ss. 6, 8, 10, 13—16, 35.