Tax Efficient Profit Extraction for Directors of Highly Profitable SMEsK Ltd. – February 2021

Total Tax Savings: £1,011,880 versus cost to formulate and implement recommendations of £9,700.


  • Family owned Private Limited Company, Mum, Dad & son, all Directors and working in the business.
  • Company financial year end is 30 June.
  • Mum is 68, Dad is 69 and son is 40.
  • Mum & Dad have made no pension contributions for many years but do have pension plans in place.
  • The company will make circa (c). £2m profit this year. 
  • The company owns the property from which it operates and this is a major business asset at c. £1.5m value. 
  • Cash at the bank c. £2.4m.
  • The Directors already draw £50,000 each in salary & dividends from the company to remain below the 40% income tax bracket.  They have no need or desire to draw more at this stage.

Key Issues:

  • On the premature demise of the parents, company owned cash and assets over and above working capital could be deemed part of their personal estate and liable to Inheritance Tax (IHT) at 40%.  Working capital for this company is c. £150,000 leaving a vast amount which will inevitably face the HMRC IHT challenge.
  • The £40,000 annual limit on Pension contributions is punitive for successful entrepreneurs.
  • Earnings over £50,000 are taxed at the higher rate of tax, 40% on earned income, and the lower rate of 32.5% on dividends as corporation tax has already been paid at 19% before dividends are paid.
  • Earnings over £150,000 are taxed at 45% on earned income and 38.10% on dividends as corporation tax has already been paid at 19% before dividends are paid.
  • Earnings from £100,000 to £125,000 effectively reduce the personal annual ‘tax free’ allowance from £12,500 to £0 creating a marginal tax rate of 60% on earnings and 48.75% on dividends.
  • How can they extract sufficient cash from the company without paying tax to create personal wealth and mitigate the risk of company assets becoming liable to IHT?
  • What options are available to reclaim tax on income that triggers the higher rates of tax?


  • To mitigate Corporation Tax.
  • To extract as much profit as possible tax efficiently from the company.
  • To grow personal wealth as opposed to company assets which could be exposed to creditors.
  • To mitigate personal Inheritance Tax (IHT) possibility on company assets.
  • To determine when to extract higher dividends triggering higher rate tax with a plan to reclaim tax through Government incentivised investment schemes.

Recommended solution for these clients:

  • Establish a specialist form of company sponsored ‘Pension Trust’ for the Directors known as a Defined Benefit Small Self Administered Scheme (DBSSAS).  That’s a real mouthful so we’ll call it a ‘Pension Trust.’
  • The Directors of the company become Trustees and Beneficiaries (Members) of the Pension Trust so that they control and own the Pension Trust assets.
  • This form of Pension Trust does not limit the Directors to the usual £40,000 maximum annual pension contribution.
  • Instead, we obtain an actuarial calculation to confirm the contribution required today to deliver a future ‘pension promise’ which is a guaranteed pension income in retirement. 
  • The actuaries have calculated that we can make contributions into the Pension Trust amounting to:
    £   337,100 for Mum
    £   373,100 for Dad and
    £   309,600 for their son

£1,019,800 in total

  • Spread over the next two company financial years with half to be paid in June and half to be paid in July following the financial year end.


  • The company claims full corporation tax relief saving 19% of £1,019,800, a tax saving of £193,762.
  • £1,019,800 is out of the company and held under the Pension Trust, which is a separate entity from the company rendering the money free from creditors and outside of the personal estates of the Directors meaning it is IHT free on death.
  • This delivers a potential Inheritance Tax saving of £407,920.
  • The Directors still retain control over the Pension Trust Fund
    • They can invest it in a wide range of options.
    • They can loan money back to their company if required.
    • They can buy commercial property for their own or other businesses to occupy as rent paying tenants.
    • They can supplement Pension Trust funds with bank borrowing to facilitate a property purchase and loan repayments are effectively paid by the rent from tenants.

Further planning option:

  • We could transfer Directors’ existing personal pensions into the company Pension Trust.
  • We could then utilise the combined funds to purchase the company property for £1.5m achieving a number of benefits:
    • Taking ownership of the property into the Pension Trust renders it free from creditors and free from IHT on death.
    • It would replace the property on the company balance sheet with £1.5m (less any capital gains tax due on profit) in cash which is liquid and easier for the company to use to mitigate IHT risk and fund future contributions into the Pension Trust.
    • The company could continue to occupy the property under a formal tenancy agreement with the new owner, the Pension Trust. 
    • Rent is paid by the company at £75,000 per annum (the market rental value) which is a tax deductible business expense saving corporation tax.
    • The rent is received by the Pension Trust as tax free income.
    • Any future growth in the value of the property under the Pension Trust is free from capital gains tax (CGT) and also free from IHT on death.
  • The additional cash in the company could be utilised to:
  • Fund additional future contributions by the company into the Pension Trust for the Directors at around £160,000 per annum for the son and around £80-90,000 per annum for Mum and Dad.
    • The Directors could also begin to extract cash from the business in the form of additional dividends up to the £100,000 level so as not to reduce their personal allowance and trigger the 48.75% effective rate of tax on dividend income between £100,000 and £125,000.
    • This additional money is spare cash, which we could invest into Venture Capital Trusts (VCTs) claiming 30% tax relief on contributions.  The investments, although higher risk, would be in smaller companies with tremendous growth potential and grow capital gains tax (CGT) free and deliver tax free dividends.
    • Further spare cash within the company bank accounts (returning zero interest) which is not required as working capital can be invested into safe asset backed investments that return c. 3% per annum yield and qualify for Business Relief (BR) rendering the money free from IHT on death.
    • Our plan could place c. £1m in such BR qualifying investments over two years ensuring that money is not subject to personal IHT at 40%, saving a further £400,000 IHT.

The above case study is an example of what can be achieved with structured planning.

The tax position is based on the rates and allowances in the 2020/21 tax year.  Tax legislation changes and our advice could be different in subsequent years.

Tax rates, pension contributions and allowances are correct at the time of this case study in the tax year 2020/21.