Making money is an objective of all businesses. As business owners, we look to extract the profits from the business in the most tax-efficient way. This will likely be a combination of salary, dividends, and pension contributions. Once the tax-efficient withdrawals have been fully utilised, how can the business make the most of the retained profits?
The answer is, get the profits working for your business by creating an additional revenue stream, capital growth, or reducing tax liabilities.
At points it makes more sense for profits to be retained in the business rather than shareholders paying tax to withdraw them from the business. Alternatively, the business may require the funds at a future point but want to make the retained profits continue growing the business rather than sitting in a bank account.
Depending on what the business is trying to achieve, different tax-wrappers and investment assets can be utilised to achieve the objective in a tax-efficient way. Examples of this can include:
If there are no immediate gains by investing in its own employees or operations, then businesses may seek to achieve financial objectives through investing. If set up and managed correctly, this could also save business owners and their families from significant tax bills.
An example of this is Business Property Relief. This is a form of inheritance tax relief available to individuals who hold shares in a private business. If your business retains excess cash (general rule is 25% of its turnover) then it may not be deemed a trading company and the beneficiaries may be liable for inheritance tax on the value of the company. When passing on a business to your family the last thing you want is for a 40% inheritance tax bill to be imposed on the shares.
One option is that the business could invest retained profits in an investment that qualifies for Business Property Relief thereby avoiding the unnecessary tax bill. These types of investments can be complex to implement so it’s important that the risks are understood and this is done to achieve a particular objective concerning inheritance tax planning.
Business Property Relief Schemes invest in assets that are high risk and can be difficult to sell, such as shares in unlisted companies.
The value of investments can fall as well as rise, you may get back less than you invested.
Tax treatment varies according to individual circumstance and is subject to change.