Personal Tax Planning

When setting up a business, the choice between a SOLE TRADER, PARTNERSHIP, or LIMITED COMPANY has significant tax (and non-tax) implications.

Comparison overview:

Tax effective rates comparison (illustrative, owner-manager extracting all profits):

At PROFITS £80,000 (above small company threshold):

• Sole trader: PA £12,570; BR band £37,700 at 20% = £7,540; rest £29,730 at 40% = £11,892; Class 4 NIC £3,419 (simplified); Class 2 small. Total ≈ £22,800.
• Company + salary to £12,570 (PA) + dividends: CT on £67,430 (£80,000 − £12,570 salary) at 19% small profits = £12,812; distributable £54,618; dividends taxed: £500 AE; remaining £54,118 mostly at 8.75% BRB + 33.75% HRB depending on level... around £10,000-12,000 on extraction. Total ≈ £22,000-£25,000.
• COMPANY route often marginally advantageous or neutral below £100k; above £100k-£125k (PA restriction zone), company can be more efficient; once in additional rate, difference narrows.

Key insight: The tax arbitrage between sole trader and company has NARROWED significantly since April 2023:

• CT main rate increased from 19% to 25% (profits > £250k)
• Dividend rates at 8.75%/33.75%/39.35% (vs pre-2016 lower rates)
• Dividend allowance reduced £500 (2024/25; was £2,000 in 2022/23)
• Marginal relief at 26.5% for profits £50k-£250k

Non-tax considerations:

• Limited liability: major benefit of company (unless personal guarantees required by banks, etc.)
• Succession and sale: shares are more liquid and transferable than partnership interests
• Credibility: "Ltd" may help with clients/suppliers
• External investment: companies can raise equity capital; partnerships cannot easily
• Administration and costs: companies cost more to set up and run
• Privacy: partnership accounts generally private; company accounts at Companies House

Partnership (LLP): often a compromise — limited liability with partnership tax treatment. Profits taxed on partners as income. LLPs are tax-transparent (partnership treatment) but provide limited liability.

Once a business is incorporated, extracting profits is a key planning decision. Main methods:

• Salary — deductible from company profits; gives NIC credits; subject to IT and NIC
• Dividends — paid from post-tax profits; no NIC; subject to dividend IT rates
• Pension contributions — tax-efficient; deductible from company profits; no IT/NIC; benefit received tax-free up to 25% at retirement
• Benefits in kind — specific items (electric car, workplace nursery) can be tax-efficient
• Loan accounts — director's loan; must be repaid or taxed; s.455 on close company loans

Optimal salary vs dividends strategy (2024/25):

Start with the personal allowance salary:

• Salary up to £12,570 (PA) is tax-free for the individual (assuming no other income)
• Company deducts salary as expense (corporation tax saving)
• Employee NIC starts at £12,570 annually (£242/week); employer NIC at £9,100 annually (£175/week)
• Using "employment allowance" if eligible: £5,000 of employer NIC waived — but only available to employers with multiple employees (not single-director companies since 2016 change)
• So the OPTIMAL SALARY for a single-director company is often around £9,100 (the employer NIC secondary threshold) to avoid employer NIC, while still getting a deduction
• For a multi-employee company: £12,570 (full PA) often optimal

After salary, top up with dividends:

• £500 dividend allowance at 0%
• Next £37,200 (within BRB given salary £12,570) at 8.75%
• Further dividends at 33.75% (HRB) or 39.35% (additional rate)

Worked example — optimal extraction:

Simon owns 100% of TechCo Ltd. Pre-extraction profits £80,000. He has no other income. 2024/25.

Strategy: £12,570 salary + dividends for the rest.

• Corporation tax: (£80,000 − £12,570 salary) = £67,430 × 19% (small profits) = £12,812
• Employee NIC on salary: £12,570 − £12,570 = £0 (at primary threshold)
• Employer NIC on salary: (£12,570 − £9,100) × 13.8% = £479
• Net profits after CT = £67,430 − £12,812 = £54,618 distributable as dividends
• Net company cost of salary: £12,570 + £479 − (£12,570 × 19% CT saving) = £10,661
• Dividend tax:
  • £500 dividend allowance at 0%: £0
  • £25,130 (PA already used by salary, so dividend in BRB = £37,700 − £12,570 = £25,130 remaining BRB) wait — actually dividend uses its own bands after the salary.
  • Let me redo: Salary £12,570 uses all of PA. Dividends fall in BRB from £12,570. First £500 at 0%; next £24,630 at 8.75% (up to £37,700 total income); remaining above £37,700 at 33.75%.
  • Actually: total taxable income = £12,570 + £54,618 = £67,188. Less PA = £54,618. Bands: BRB £37,700 (filled by: nothing from salary since within PA; £500 dividend at 0% + £24,630 dividend at 8.75%); above BRB: £25,988 at 33.75%.
  • Dividend tax: £24,630 × 8.75% + £25,988 × 33.75% = £2,155 + £8,771 = £10,926
• Total tax and NIC: £12,812 CT + £479 employer NIC + £10,926 dividend IT = £24,217
• Take-home: £80,000 − £24,217 = £55,783 (after all taxes)

Compare all salary:

• CT = (£80,000 − £74,420 salary − £10,276 employer NIC) × 19% = nil (loss-making? No, company saves CT)
• Actually: for salary of £80,000 gross, employer NIC = (£80,000 − £9,100) × 13.8% = £9,784. Total cost to company: £89,784 — exceeds £80,000. So max gross salary leaving zero company profit is about £70,000. Too complex for this example — dividend route clearly preferable.

Compare all dividends:

• CT on full £80,000 at 19%: £15,200
• Dividend £64,800; dividend IT: first £500 at 0%; £12,570 PA applied against dividends (no salary first); so remaining £52,230 taxed as dividends — around £12,000 to £15,000 depending on bands
• Typically yields lower take-home than mixed strategy

Pension contributions:

• Employer pension contributions: FULLY DEDUCTIBLE from company profits (subject to "wholly and exclusively for trade" test — normally met for executive directors)
• No income tax or NIC on the employee
• No employer NIC
• Employee can access 25% tax-free lump sum at age 55 (57 from 2028); rest taxed as income
• Best done via the company, not personally — company gets CT relief at up to 26.5%; individual pension contribution at source only gets basic-rate relief without extension
• Subject to AA £60,000 (tapered if high earner)

Mixed strategy for owner-manager:

1. Take salary up to employer NIC threshold (£9,100) or PA (£12,570) depending on employment allowance eligibility
2. Take dividends up to basic rate band (favourable 8.75%)
3. Consider pension contribution (up to AA) for higher-level extraction
4. Only take additional rate dividends if cash is needed (33.75%/39.35% — high tax)

IR35 (intermediaries legislation, Chapter 8 ITEPA 2003) targets personal service companies (PSCs) — individuals who would be employees if they provided services directly, but use an intermediary company to reduce tax/NIC.

The "deemed employment" test:

• Would the individual be an EMPLOYEE of the client if they contracted directly (not via the PSC)?
• If YES → deemed employment; the PSC must operate PAYE as if the fees were a salary
• Loses the tax advantage of incorporation

Tests for employment (case law-derived):

1. Mutuality of obligation — must client provide work, and must worker do it?
2. Control — does the client control HOW, WHEN, WHERE work is done?
3. Personal service — must the individual do it personally (vs right to substitute)?
4. Financial risk — does the worker bear financial risk (vs guaranteed payment)?
5. Integration — is the worker integrated into the client's organisation?
6. Equipment — who provides tools/equipment?
7. Contract terms — but real-world conduct matters more

Chapter 10 / "off-payroll working" rules (from April 2021 for private sector):

• Responsibility for determining IR35 status SHIFTED from the PSC to the END CLIENT (for medium/large private sector clients; public sector since 2017)
• "Small client" exemption: clients under 2 of 3 thresholds (turnover < £10.2m; balance sheet total < £5.1m; employees < 50) → PSC still determines status
• End client gives a "Status Determination Statement" (SDS) to the PSC and fee payer
• If INSIDE IR35: fee payer (usually agency or end client) deducts PAYE before paying the PSC
• PSC receives payment NET of deemed tax/NIC
• Reform introduced to HMRC collection on a "pay-as-you-go" basis — reduces non-compliance risk

Tax consequences of IR35:

• PAYE deducted by fee payer on deemed payment
• PSC treats net receipt as its turnover and profits
• Extraction from PSC: dividends from already-taxed profits → minimal further tax (otherwise would create double taxation)
• Dual running: quarterly VAT and CT returns still due; the PAYE is an ADDITIONAL burden

Practical impact:

• Increased compliance cost
• Reduced net income for contractors affected
• Some companies reluctant to engage PSCs (they bear the risk of wrong status determination)
• Professional advisers increasingly important — reviewing contracts, conduct, and making determinations

CEST tool: HMRC's Check Employment Status for Tax tool. Used for determinations. Binding only if HMRC approves and facts are accurate; criticised for being simplistic and pro-HMRC.

UK tax status depends on RESIDENCE and DOMICILE.

Residence (under Statutory Residence Test from 2013/14):

• Automatic UK tests: 183+ days UK in tax year; UK home for 91+ days (where present 30+); works full-time in UK. If ANY met: UK resident.
• Automatic overseas tests: fewer than 16 days (if resident previous year) or 46 days (if not resident last 3); works full-time overseas with minimal UK days. If ANY met: not UK resident.
• Sufficient ties test (if no automatic test met): combination of UK ties (family, accommodation, work, 90-day ties, country tie) + days in UK. Table determines residence.

Effect of UK residence:

• UK RESIDENT: Taxable on worldwide income and gains
• NON-RESIDENT: Taxable only on UK-source income (and UK property gains since April 2015)

Split-year treatment: for tax year of arriving in / leaving UK — split into UK and non-UK parts.

Domicile (PRE-APRIL 2025):

• Domicile of origin: acquired at birth, usually from father (or mother if illegitimate/deceased father)
• Domicile of choice: acquired by moving to another country with settled intention
• Deemed domicile: UK resident for 15+ of 20 previous tax years, OR UK born with UK domicile of origin and UK resident in year of charge

Remittance basis (for non-UK domiciled):

• Non-UK domiciled individuals can elect to be taxed on ARISING basis (worldwide) or REMITTANCE basis (UK income/gains + foreign income/gains brought to UK)
• Remittance basis charge (RBC) annual: £30,000 (7 of 9 prior years UK resident), £60,000 (12 of 14 prior years)
• Available up to deemed domicile threshold (15 years)
• Loses personal allowance and AEA when claiming RB

MAJOR REFORM — April 2025:

• The remittance basis and deemed domicile concepts are being ABOLISHED from 6 April 2025
• Replaced with a NEW RESIDENCE-BASED regime:
  • First 4 YEARS of UK tax residence (provided non-resident for 10 years prior): CAN EXCLUDE foreign income and gains from UK tax — "Foreign Income and Gains regime" (FIG)
  • After 4 years: fully in UK regime on worldwide basis
• Transitional provisions for existing non-doms
• IHT also transitions from domicile-based to residence-based (10 of 20 years UK resident → worldwide assets in scope for IHT)

Planning under the new regime:

• New UK arrivals (after 10+ years non-residence): 4 years of FIG shelter — significant benefit during initial UK period
• Long-term non-doms: should re-evaluate all structuring; consider timing of income/gains realisation
• Non-UK trust structures: complex rules — may need restructuring
• Consider becoming non-UK resident before meeting the 10 of 20 years threshold to avoid worldwide IHT

UK pensions offer significant tax advantages:

• Contributions: tax relief at marginal rate — up to AA
• Growth: tax-free within the pension fund
• Lump sum at retirement: 25% of fund TAX-FREE (up to LSA £268,275)
• Income from pension: taxed as income at recipient's marginal rate (usually retired, so often lower rate)

Annual Allowance (AA) — recap:

• Standard AA: £60,000 (2024/25)
• Tapered AA for high earners: £1 for £2 reduction over £260k adjusted income; minimum £10k at £360k
• MPAA £10,000 if accessed pension flexibly
• Carry forward: unused AA from previous 3 years (if scheme member)

Types of pension contribution:

Why employer contributions are powerful for owner-managers:

• £10,000 employer contribution costs: ~£8,100 after CT relief (if 19% rate) or ~£7,350 (if 26.5% marginal rate)
• No IT, no NIC on the director receiving it
• Grows tax-free in the pension
• 25% tax-free at retirement; rest at marginal rate (often lower in retirement)
• Effective value: for every £1 of cost, ~£1.10 into pension (after CT saving)

Pension as an extraction tool vs dividend:

• Dividend at 33.75% HRB: £10,000 dividend costs company £10,000 post-tax (after CT already paid); individual gets £6,625 in pocket
• Employer pension £10,000: costs company £8,100 (CT saving); full £10,000 in pension (grows tax-free); 25% tax-free + 75% at retirement marginal rate
• PENSION IS MORE TAX-EFFICIENT but LOCKS UP until age 55/57

Planning considerations:

• Employer contributions must be "wholly and exclusively" for the trade — generally accepted for executive directors whose remuneration packages are reasonable
• Spouse pension contributions: if spouse is a director/employee, company can contribute to their pension — use their AA too
• Carry forward: plan multi-year contributions — large one-off contributions in year of high earnings
• Tapered AA: high earners (> £260k adjusted income) may only have £10k AA — use carry forward if needed
• Pension freedoms (from 2015): flexible access to DC pensions from age 55 (rising to 57 from 2028) — drawdown, lump sums, annuities, leave invested

The UK tax system offers several vehicles for tax-advantaged investment.

Enterprise Investment Scheme (EIS):

• 30% income tax relief on subscription (up to £1m per tax year, £2m if at least £1m in "knowledge-intensive" companies)
• CGT exemption on gains when EIS shares held for 3+ years (the EIS shares themselves)
• CGT reinvestment/deferral relief — any gain deferred by investing in EIS (1 year before or 3 years after)
• Loss relief against INCOME (s.131 ITA 2007) — for unlisted trading shares that lose value
• IHT BPR — most EIS companies are unquoted trading companies, qualifying for BPR after 2 years
• Conditions: qualifying trading company, < 250 employees, < £15m gross assets, company < 7 years old (10 for knowledge-intensive)
• Hold shares ≥ 3 years to keep the IT relief

Seed EIS (SEIS):

• 50% income tax relief on subscription up to £200,000 per tax year (increased from £100k in April 2023)
• CGT exemption on gains after 3 years
• CGT REINVESTMENT EXEMPTION (50%) — 50% of any gain is EXEMPT when reinvested in SEIS (not just deferred)
• Loss relief against INCOME
• Conditions: very early stage (company < 3 years trading, < 25 employees, < £350k gross assets — increased from £200k)
• Same 3-year holding period

Venture Capital Trust (VCT):

• 30% income tax relief on subscription up to £200,000 per tax year
• Dividend income: TAX-FREE from VCTs
• CGT exemption on disposal of VCT shares
• Conditions: HMRC-approved VCT (listed on LSE); invests in qualifying small trading companies
• Hold VCT shares ≥ 5 years (to keep the IT relief)
• Liquid (listed) — easier to trade than direct EIS/SEIS

Comparison of EIS/SEIS/VCT:

Worked example — EIS tax benefits:

Jason invests £100,000 in qualifying EIS shares in 2024/25. He is an additional rate taxpayer. He also has a recent CGT liability of £50,000 on share sale.

• IT relief: 30% × £100,000 = £30,000 (reduces his income tax bill directly)
• CGT deferral: reinvest £50,000 of the recent gain — defers the £50,000 gain
• Net cost of investment: £100,000 − £30,000 IT relief = £70,000 (plus £50,000 deferred CGT)
• If he holds for 3+ years and sells at a gain: the future gain is CGT-exempt (saves 20%+)
• If the investment fails: loss relief against income at 45% on remaining base cost (after IT relief)
• Effective downside protection: max loss ≈ 38.5% of original (after IT relief AND loss against income relief)

Individual Savings Accounts (ISAs):

• Tax-free wrapper for savings and investments
• Annual limit £20,000 (2024/25)
• No tax on interest, dividends, or capital gains within the ISA
• No annual limit on holding period; ISA benefits preserved in future years

ISA types:

• Cash ISA: savings accounts
• Stocks & Shares ISA: investments (shares, funds, bonds)
• Innovative Finance ISA (IFISA): peer-to-peer lending and crowdfunding
• Lifetime ISA (LISA): for ages 18-39; £4,000 annual limit; 25% government bonus (£1,000 max per year); for first home (up to £450k) or retirement (from age 60); 25% withdrawal penalty for other use
• Junior ISA: for under-18s; £9,000 annual limit; owned by child, parents control until 16

ISA planning:

• Use annual allowance EVERY YEAR — unused allowance LOST
• Max dividend tax saving: higher-rate taxpayer with £10,000 dividend in ISA vs outside ISA saves £3,000+ per year in tax
• Transfer existing ISAs between providers — no tax consequences
• LISA for first-time buyers under 40 — 25% bonus is very valuable
• Spouse transfers on death: inherited ISA allowance (Additional Permitted Subscription — matches deceased spouse's ISA value)

Family tax planning involves legitimate allocation of income and assets among family members to minimise overall tax. Subject to significant anti-avoidance rules.

Income and asset splitting with spouse/civil partner:

• Spouse/civil partner transfers at no gain/no loss for CGT (covered in CGT Advanced)
• IHT-exempt between spouses
• Marriage allowance: £1,260 PA transferable from basic-rate non-employed spouse to basic-rate earning spouse (saves £252)
• Jointly-held property: income typically split 50/50 unless election for different split (Form 17 declaration of beneficial ownership)
• Higher-rate spouse shifts savings/investments to lower-rate spouse: dividends at 8.75% instead of 33.75%/39.35%; interest at lower tax; CGT at lower rate and using second AEA

Worked example — spouse planning:

A couple: husband £120,000 income (additional rate territory with PA reduction), wife £0 income. They have £50,000 of dividend income from investments jointly owned 50/50.

• Current: £25,000 to each. Husband taxed at 33.75% + 39.35% mix on his £25k: approx £8,000 tax. Wife tax-free (within PA).
• Planning: transfer investments to wife entirely. She receives £50,000 dividends.
  • Wife: PA £12,570 offsets £12,570 of dividends (actually PA used first against non-dividend income if any; wife has no other income so PA offsets £12,570 of dividends, leaving £37,430)
  • Basic rate band £37,700 partially covers remaining; £500 DA at 0%; balance at 8.75%
  • Tax: approx £500 × 0% + £37,000 × 8.75% ≈ £3,200
• Saving: ~£5,000-£8,000 annually. Transfer is at no gain/no loss — no CGT cost.

Children — planning constraints:

• Children under 18 have their own PA (£12,570) and tax bands
• BUT: "settlements" rules (Income Tax (Trading and Other Income) Act 2005 s.629) — income from PARENT'S GIFTS is TAXED ON THE PARENT if child is a minor. Limit £100/year per parent per child before this applies.
• Grandparent or non-parent gifts to children — child's own income for tax purposes
• Junior ISA (£9,000/year) — tax-free, child's own
• Pension contributions for children — £3,600 gross contribution for non-earning child; builds retirement fund early with tax relief

Family investment companies (FICs):

• Investment company owned by family members; used for long-term wealth accumulation
• Profits taxed at CT (25% on investment income — but only on accrual; 19% for non-investment small profits)
• Extraction at family members' marginal rates via dividends
• IHT: shares can be given away to build lifetime gifting; growth in company stays outside the parent's estate
• FIC can retain earnings within the company at CT rate — deferring higher personal IT

Anti-avoidance — settlement rules:

• Income deemed to be the settlor's: income from assets gifted to spouse/child may be taxed on the SETTLOR (donor) if retained interest
• Applies to most "settlements" where donor retains any benefit or interest
• Spouse exemption: transfers between spouses generally not caught (UNLESS outright gift retaining income)
• Case Arctic Systems (Jones v Garnett) — HMRC lost case on spouse splitting of dividends
• Careful structuring needed

Anti-avoidance — transfers of assets abroad:

• Detailed rules (ITA 2007 Part 13) counteract UK residents' use of offshore structures to avoid UK tax
• Can result in offshore income being attributed back to the UK-resident individual
• Motive defence — available if arrangement was not motivated by tax avoidance

General points:

• Legitimate family planning: spousal income-splitting, use of reliefs, JISAs, pension contributions — all acceptable
• Aggressive planning (offshore structures, artificial trusts) — vulnerable to GAAR, settlements rules, transfer of assets abroad rules
• Document intention and commercial rationale