Updated on: Jan 22, 2024
Today I want to take a look at some real-life examples of how our contractor clients can get more tax efficient by getting their company to pay for a selection of benefits directly from their business bank account.
Want to watch our YouTube video instead? It summarises the main points but refer back to this article for more in-depth information.
Paying yourself from your company
It is well accepted that there are four main ways of extracting funds from your limited company. These are (a) taking a salary (b) paying yourself dividends (c) paying yourself a loan (d) paying yourself back for business related expenses that you have paid for personally.
There is also another way of extracting funds from your business and that is by having your company pay for things that you might usually not consider to be business expenses. There are a series of rules around this however and the guidelines from the HMRC are clear as to how this works and what needs to be reported on your P11D.
Non Business-Related Expenses
Firstly, I just wanted to cover this off before you start thinking you can put any costs that you like through your limited company. Your company cannot pay for your weekly groceries, it cannot pay for your Netflix subscription, it cannot pay for a new Xbox, and generally speaking it cannot pay for any clothing, WITHOUT there being a taxable benefit charge on you personally. So, when looking at extracting funds from your limited company you need to consider what payments and benefits are non-taxable, because this is where a tax benefit can be gained.
What are Taxable Benefits
Taxable benefits are non-cash benefits provided by an employer to an employee that are subject to income tax. The most common type of benefits provided by employers in the UK are things such as company cars, private health insurance, life insurance, interest free loans, accommodation, and providing assets to an employee where there is a significant amount of personal use.
The benefits available to most employees are dictated by what their employer makes available to them. In the case of our limited company clients the situation is a little bit different because they can effectively act as both the employer and the employee at the same time. What I mean by this is that the contractor can decide that their ltd company can pay them whatever benefits they like and are not restricted by any HR policies or senior management teams that larger employers have. Because of this, the contractor is in a unique position to determine what benefits their company can pay and often the decision will be based around how those benefits are taxed.
An example of a Taxable Benefit
Let’s quickly run through an example of how the tax on a benefit is calculated. Let’s say Marie has her own limited company and has been contracting in the UK for over two years. She recently saw a Netflix series on body sculpting and has decided she wants to hit the gym hard for the next 12 months. Her gym membership costs £60 per month, and she has set up a corporate plan where her company pays for her gym membership directly. While being an allowable business expense, a gym membership is a typical taxable benefit and so the usual tax rules will apply.
Annual cost: £60 x 12 months = £720.
Because the gym membership is a taxable benefit this will need to be reported on the company P11D at the end of every year, and this cost is subject to class 1A National Insurance contributions. The rate from 6 April 2023 to 5 April 2024 on expenses and benefits is 13.8%, so this gym membership would create a Class 1A NIC cost of 720 x 13.8% = £99.36. Note that while the employers NIC allowance can be used to reduce the employers NIC cost, this does not apply to P11D taxable benefits.
We would typically code a gym membership expense to “Staff Costs” in our clients Profit & Loss account and assuming her company pays corporation tax at a rate of 19%, her company would see a corporation tax reduction related to both the cost of the gym membership and the class 1A NIC, as these two expenses will reduce the company’s profits. The reduction in company tax would be (720 + 99.36) x 19% = £155.68.
Income tax (PAYE)
In receiving a taxable benefit from her company, Marie will face a tax bill based on the value of the benefit, and the amount of tax that she pays will depend on her income tax band when considering all of her income from all sources. In this example after taking into account all relevant UK earnings, let’s assume Marie is a basic rate taxpayer which means she will pay income tax at 20%. Overall, the amount of income tax Marie will need to pay will be 720 x 20% = £144.
Summary – Taxable Benefit
The gym membership for Marie has a net cost to the company of £720 + 99.39 – 155.68 = £663.71. The overall net value of the benefit to Marie is 720 – 144 = £576. In this case the net cost to the company exceeds the net value that Marie gets, so from a tax efficiency point of view she is worse off by getting the company to pay for her gym membership. To be more tax efficient she should just pay for it personally.
Summary – Dividend
Lets consider the scenario where Marie takes a £720 dividend from her company instead and pays for the gym membership personally. As a basic rate taxpayer whose dividend allowance is used up already, dividends are taxed at 8.75%, so the dividend tax she would pay is 720 x 8.75% = £63. This makes the net value of the benefit to Marie equal to 720 – 63 = £657. As a result, you can see she gets much better value taking the dividend when compared to having the company pay (where the overall net value of the benefit to Marie was only £576).
An example of a Non-Taxable Benefit
In the case above we were able to show that providing yourself with a taxable benefit leaves you worse off from a tax perspective. But what happens when your company supplies you with a benefit that is not taxable. For example, let’s say Marie is required to work at a computer screen for her contracting work, and to do so she is required to wear glasses. In this case an eye test and the cost of the glasses are exempt from being a taxable benefit. The cost of both the eye test and glasses for Marie totals £300.
Being a non-taxable benefit there is no employers national insurance contributions.
We would typically code eye tests and glasses to “Staff Costs” in our clients Profit & Loss account and assuming her company pays corporation tax at a rate of 19%, her company would see a corporation tax reduction of 300 x 19% = £57.
Income tax (PAYE)
Being a non-taxable benefit there is no income tax to pay.
Summary – Taxable benefit
The eye test and glasses for Marie has a net cost to the company of 300 – 57 = £243. The overall value of the benefit to Marie is £300. In this case the net cost to the company DOES NOT exceed the net value that Marie gets, so from a tax efficient perspective she better off getting the company to pay for her eye test and glasses.
Summary – Dividend
Lets consider the scenario where Marie takes a £300 dividend from her company instead and pays for the eye test and glasses personally. As a basic rate taxpayer (and assuming her tax free dividend allowance has been used up), dividends are taxed at 8.75%, so the dividend tax she would pay is 300 x 8.75% = £26.25. This means the net value of the benefit to Marie is reduced to 300 – 26.25 = £273.75. So you can see, she gets worse value taking a dividend when compared to having the company pay for the tax free benefit (where the overall value of the benefit to Marie was a healthy £300).
What Payments and Benefits are Non-Taxable?
Having been through the two scenarios above you are now probably thinking “OK great, please provide me with a list of all payments and benefits that are non-taxable”, so that you can start running them through your business. There is actually quite a long list of business expenses that fall into this category however most of them do not apply to limited company contractors. For example, free or subsidised meals are non-taxable benefits and are also an allowable business expense which sounds great however the following conditions must be met;
(a) the meals must be provided on your employer’s business premises, or in any canteen where meals are provided for staff generally;
(b) the meals are provided on a reasonable scale;
(c) and either (i) all employees can get free or subsidised meals; or (ii) your employer provides free or subsidised meal vouchers for staff who do not get meals.
You get the idea. A lot of the available non-taxable benefits are geared towards larger employers and the conditions required simply do not suit limited company contractors who often are the only employee in their company. But there are some tax-free benefits that can be used and here is a quick list.
Any benefit costing less than £50 will not be a benefit-in-kind provided that the benefit is not in the form of cash or a cash voucher and it is not given in recognition of work done. Where the individual is a director in a close company (like our clients are) the total value of trivial benefits cannot exceed an annual cap of £300.
Employer contributions into a pension
Employer contributions to an employee’s pension scheme are not taxable on the employee provided they are within certain limits. When making higher personal pension contributions though just be aware of how long those funds will be tied up for before you can access them.
Health screening and medical check-ups
Expenses incurred in providing you with a maximum of one health screening assessment and one medical check-up in any year are exempt while also being a tax deductible expense for the company.
Eye tests and corrective glasses are not taxable where an employee uses a visual display unit (VDU), and the provision of a test and glasses is required by Health and Safety regulations.
Christmas or other annual party
Annual parties or alternative functions of a similar nature, such as a Christmas dinner or a summer party, which are open to staff generally and which cost no more than £150 a head in total to provide are tax free benefits.
Mobile phones and smartphones
There is no taxable benefit on one mobile phone provided to you by your company, or any associated line rental costs. The phone contract needs to be in your employer’s name.
Bicycles and cycling safety equipment
The cost of purchasing a cycle plus associated safety gear is it tax free benefit provided certain conditions are met. The company also gets corporation tax relief for the expenditure. We cover this off in a separate blog article here.
Home working allowance
If you work from home for part or all of the week, your company can pay you a home working allowance to reimburse you for additional household expenses, such as gas and electricity. A payment of £26 per month (maximum) is allowed with no record keeping required.
Relevant Life Insurance
Relevant life insurance is a type of life cover provided by the employer, offering tax benefits and protection for its employees and directors. It is a cost-effective solution allowing you to safeguard your family while also benefiting from tax savings.
Summary of Tax Efficient Options
In this article I have highlighted the significance of choosing benefits provided by your limited company considering their tax implications on corporation tax, dividend tax, and income tax. For limited company contractors, it’s very useful to understand what constitutes taxable and non-taxable benefits.
While you have the freedom to decide the benefits your limited company provides, it also holds tax implications that require careful consideration. The given examples demonstrate this, where the net cost of a benefit to your company could outweigh the net value gained.
The best strategy is to look at non-taxable benefits, and the ones most suitable for limited company contractors include trivial benefits, employer pension contributions, health checks, company parties, mobile phones, bicycles and safety equipment, and a home working allowance.
If you are considering having your company pay for a taxable benefit, its usually better that you take a dividend and pay for the cost personally.
Overall, our contractor clients need to consider fully the tax implications of both taxable and non-taxable benefits to maximise their tax efficiency. Remember, efficient tax planning is a crucial component of managing your finances as a limited company contractor.