Managing cash in your business

With interest rates at a record low in the UK, and with dividend tax rates now going up all to way to 38.1% for additional rate tax payers, many small businesses are reluctant to extract money from their limited company and are wondering how to make that cash left in the business produce significant income. Unfortunately there is not one single answer and each available options comes with its own benefits and drawbacks.

Savings Account

The simple answer is to open a savings account for the company. Most banks will allow for that but unfortunately the rates are ridiculously low. Major banks will typically pay between 0.5% and 1% depending on how long you are willing to lock your money for. And while it's possible to find slightly better rates at smaller banks or financial institutions, one has to be aware that the Financial Services Compensation Scheme (FSCS) that protects personal accounts up to £85,000 is not always available for Limited Companies.

Investment Account

For the more sophisticated entrepreneur, it is also possible to open a share and fund dealing account to invest the cash of the business. Not all brokers will allow for a company to open an account so you need to double check that service is offered to Limited Companies as well. For example, AJ Bell does not offer such a service but Interactive Investor does.

But investing through a limited company brings a lot of problems of its own.

1. One has to keep in mind that the capital gains allowance (currently £12,000) is only available for private investors not companies. Gains realised inside the company will therefore be taxed at 19% from the first pound. While in the past there was an indexation allowance available for companies it has been removed from 1 January 2018.
2. Also as a private investor, using an ISA you can invest tax free (currently up to 20,000 per year), something that again a company is not able to do.
3. Having an "investment business" alongside a "trading business" puts the "trading" qualifier at risk. While it's not a problem anymore from a corporation tax standpoint, it might be a problem down the road if one were to sell or liquidate the company. Being a trading business allows the shareholder to claim Entrepreneur's Relief (i.e. a reduced tax rate of 10% rather than the standard 20%). And unfortunately, it's quite easy to have a trading business disqualified since it's not just income the HMRC will look at but the size of the assets producing income (see HMRC Capital Gains Manual).

Payment into SIPP

A very attractive option one can be sure that the cash will never be needed in the future and if one's pension plan has not been maxed out is for the company to pay directly into the director's pension plan. Pension plans held in a SIPP are extremely flexible when it comes to investment and it's the most tax efficient approach if it's possible.

For most directors, it's possible to invest up to £40,000 directly into the pension, bypassing corporation tax, NIC contributions and income tax for the director. Once into the pension the money can be invested tax free but it's locked until one is 55.

Extraction as dividend and re-investment into an EIS or VCT

Should one not want to lock money for a long period, it's also possible to extract money as dividends and invest it into tax efficient investments such as EIS, SEIS or VCT. While it means that dividends tax will have to be paid, because those investments offer a cash refund from HRMC of 30% to 50%, the dividend tax is in practice cancelled out. The downside is the holding period of those investments which, if it's in theory no longer than 3 to 5 years as per the regulatory requirements, it's in practice longer than that because of the nature of the investment.