Tax efficient investments for limited companies

As a limited company director, it’s a typical issue to have those well-earned profits tied up in the business.

After utilising dividends and salary, it can feel like there is little left to do other than to simply leave the money in the business, as nobody really wants to give rise to paying additional income tax!

Sadly, with interest rates remaining as low as they have been for many years there is little return to be had on business cash rates, and although stocks and shares can be an option, this doesn’t negate the tax for directors when they will want to realise the money at some point.

So, writes financial adviser Angela James of ContractorUK pension partner Yolo Wealth, what can you do in response, and what are the options for limited company directors when it comes to making tax-efficient investments?

1. Pensions

If you aren’t taking care of your future retirement, then this is the first thing you should be considering as a limited company director or contractor!

A pension is the single most tax-efficient investment available to all and you could receive immediate tax relief by doing so. Whether it is via personal contributions or employer contributions direct from the business, this money is not treated as benefit, meaning it is exceptionally tax efficient.

Currently, £40,000 is the annual pension allowance which can be paid into a pension each tax year, subject to individual qualifying criteria. Any pension contributions made by the company itself reduce your business profits, meaning your profit is reduced and in turn your corporation tax bill is reduced too. Plus, this course of action immediately places the money into your own name rather than belonging to the company.

2. Individual Savings Accounts (ISAs)

Although only available to an individual, meaning a business entity is not entitled to an ISA, an Individual Saving Account is still a tax-efficient home for your money after drawing down from the business. Although investing in an ISA would give rise to dividend tax when drawing from the business, it is still worth considering as a tax-savvy investment.

Crucially though, ISA allowances that are unused are lost each financial year and there is no way to carry these forward.

More positively, once money is invested into an ISA then no further tax is liable on your money. The money will grow tax free and is not a taxable income when you look to withdraw or take an income from it later.

3. Private Investments

These types of investment are an opportunity for you to invest your money into other businesses, helping early or seed stage companies, à la ‘Dragons’ Den.’

A common way for an average investor to do this while spreading the risk is to use investments such as Venture Capital Trusts or Enterprise Investment Schemes.

By investing through a collective VCT or EIS, you are able to invest through a pooled investment and sometimes established collective investment schemes into many companies which would spread your risk more than simply investing into a new private business.

These investments offer immediate tax credits which as a company director can offer the opportunity to mitigate a large proportion of the tax paid to draw the extra dividend.

However, they are not without additional risks and for that reason advice should be sought for these types of investments. 

4. Venture Capital Trusts (VCTs)

An individual is able to invest up to £200,000 per annum into VCTs and can claim upfront tax relief at 30% on the amount invested.

This tax credit can be offset against your total tax liability in the same tax year.

An example:

Limited company director Jan takes an additional gross dividend of £10,000 over the higher rate tax threshold to invest. The net dividend after tax is £6,750 and the additional tax is £3,250.

This £10,000 is then invested for Jan into a VCT investment for a minimum of 5 years. Jan would receive a £3,000 tax credit for the VCT investment. Meaning the effective tax payable by Jan on the extra dividend is £250.

Fortunately, the fund grows free from Capital Gains Tax and the dividend payments on a VCT are also tax exempt and do not affect the annual dividend allowance.

But these investments must be held for a minimum of five years and given the nature of investing in newer businesses, means they are high-risk investments.

Please note, Venture Capital Trusts (VCT) and Enterprise Investment Schemes (EIS) invest in assets that are high-risk and can be difficult to sell, such as shares in unlisted companies. The value of the investment and the income from it can fall as well as rise and investors may not get back what they originally invested, even taking into account the tax benefits.

Finally, before making any decision, get professional financial advice tailored to your circumstances

The above is just a high-level summary of some points that could be explored by limited companies wanting a tax-efficient investment (or two!). But almost every investment has complexities so we always recommend seeking appropriate advice from a trusted, established, and qualified financial adviser before making any decisions.

Editor’s Note: The content of this article should be taken as information only and does not constitute financial advice

Please further note, the value of pensions and investments can fall as well as rise, you may get back less than you invested.

Tax treatment varies according to individual circumstances and is subject to change.

The Financial Conduct Authority does not regulate Tax Planning Advice

Yolo Wealth is a trading style of Yolo Wealth Management Ltd, an appointed representative of Quilter Financial Services Ltd and Quilter Mortgage Planning Ltd which are authorised and regulated by the Financial Conduct Authority.

Thursday 10th Jun 2021

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