Tax efficient cash extraction from Companies

Tax efficient cash extraction from Companies

I have a company that has built up cash reserves over the years but if I try to remove it HMRC want to take tax from me. What can I do?

This is a vexing question that is often asked by clients. Having a surplus of cash in a company can affect future tax charges on individual shareholders but attempts to remove the cash can produce significant personal tax liabilities.

There are a number of ways of removing cash from companies including that old nutmeg – pensions. This is a great form of planning but in most cases it is very long term.

So what else is available?

The Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT) both offer significant tax incentives to investors, and used creatively, they provide some remarkable tax planning opportunities.

The two schemes both offer immediate income tax reducers at a rate of 30% on the amount invested, and in both cases any capital gain when the investment is realised is tax free. Briefly the tax reliefs can be summarised as follows:

 Tax Relief

EIS

VCT

Income tax relief at 30%

Up to £1,000,000 p.a.

Up to £1,000,000 p.a.

Must hold investment for

3 years minimum

5 years minimum

CGT exemption on disposal

Yes

Yes

CGT deferral

Yes

No

Business property relief for IHT

Yes (after being held for 2 years)

No

Tax free income from investment

No

Yes

In the case of the EIS, capital gains of any amount can be deferred by investing the amount of the gain in an EIS company. The gain becomes chargeable when the investment is cashed in but can be deferred again if another EIS company is invested in.

The types of business which can qualify for EIS or VCT status are tightly defined. There are several providers in the marketplace who design specialised investment vehicles which qualify for these tax reliefs.

These investments have traditionally been regarded as “risky”, but there are now some products available which minimise the risks associated with investing in trading companies (which is essentially what both schemes involve).

So how can these schemes be used for cash extraction?

Higher rate taxpayers pay an effective rate of 25% tax and EIS and VCTs attract relief at 30% so if an individual takes a dividend of £50,000 from his company he will only need to invest £41,667 into a EIS/VCT to cover the extra tax liability leaving £8,333 in his pocket. At the end of the holding period the investment the cash has been extracted from the company not only tax free but with a bonus.

Considerations such as the loss of personal allowances need to be taken into account.

It is to be hoped that the EIS/VCT investment will make a return or at least the cash back. Therefore careful consideration and appropriate financial advice is imperative. Risk is a major consideration when undertaking such a strategy.

If anyone wishes to discuss this issue please contact Robyn Hughes or Mike Scott in our tax team on 0845 365 1000