Although the goal of every business is to make profit, it can take a long time. But once that milestone is achieved, directors are faced with the problem of how best to take profits while minimising their tax bill.

Salaries reduce your profits and, in turn, your Corporation Tax bill, so this is the most obvious way to move cash out of your business. Depending on the individual's circumstances, there’s generally no tax on the first £11,000 of earned income and then 20% is due on anything taken up to £43,000. However, both the business and the directors will be liable to National Insurance contributions (NICs)

An alternative form of remuneration is dividend income. Historically, many business owners have preferred to receive a proportion of their pay in the form of a dividend because, although taxable, NICs are not due; thus, dividends have often made up the bulk of income drawn from owner-managed small businesses.

However, since April 2016, directors of small or medium-sized companies adopting this approach have faced the prospect of higher tax bills. The 10% notional tax credit that compensated for the Corporation Tax already paid on profits distributed as dividends was abolished and replaced with a £5,000 annual dividend allowance. Basic rate taxpayers now pay 7.5% tax on any additional dividend income, higher rate taxpayers pay 32.5% (instead of an effective rate of 25% in 2015/16), and additional rate taxpayers 38.1% (instead of an effective rate of 30.55% in 2015/16.)

These changes particularly affect directors who pay themselves a small salary designed to preserve entitlement to the State Pension, supplemented by a much larger dividend payment in order to reduce NICs. In most cases, the combination of a small salary and dividends is still going to be the better option, although the new dividend taxation rules may mean that you may pay more tax, depending on the levels of the dividend distribution.

Profit in pensions

However, there is another way of cutting your tax bill while at the same time helping with wealth accumulation. Company pension payments are deductible as a company expense and can therefore reduce or wipe out liability to Corporation Tax. Additionally, under pension freedoms rules, those over the age of 55 can take the whole of their money purchase pension fund back and use the cash broadly as they wish – including up to 25% of the total fund tax-free – with the remainder subject to Income Tax.

Furthermore, for those who can look beyond immediate income needs, pensions offer genuine estate planning opportunities. Regardless of whether a defined contribution pension is already being drawn or not, it can pass tax-free to any beneficiary if death is before 75. Even after 75, beneficiaries do not pay Inheritance Tax, only Income Tax at their marginal rate, and then only when the money is withdrawn from the pension.

You can add up to £40,000 to your pension this tax year using pre-tax profits from your business. If you have not made a pension contribution this tax year, or in the previous three, you could use the ‘carry forward’ rule to add up to £170,000 to your pot. By taking it from the business, not only will you have reduced your company’s liability to Corporation Tax; you will also have saved Income Tax, including on dividends, and NICs (both personal and business) on those contributions.

It is important to note that pension contributions will need to be paid before your company’s financial year-end in order for the business to qualify for Corporate Tax relief in that accounting period. A popular year-end date for many companies is 31 March, so owners of the business should try to bring forward pension contributions to before this date if it’s applicable.