Tax credits planning for businesses - some examples

Below are a series of situations where significant tax credits have been successfully claimed. The examples given are real stories which happened in 2009/10; however the names have been changed to preserve their anonymity.

Pension – Pension payments are deducted gross from your “Income” for tax credit purposes. For example if you contributed £8,000 (net) to a personal pension, then this is treated as a gross contribution of £10,000 to your own pension. However this £10,000 is then deducted from your "Income" figure for tax credits purpose.

John and Anne – Anne pays a pension: Anne paid a net pension contribution of £10,100 producing a gross pension contribution of £12,625 to the pension fund, at a net cost to Anne of £1,577 after refund of tax credits.

Capital equipment e.g. purchase of a van – the purchase of a van would usually reduce taxable profits by the cost price of the van, therefore reducing tax credit income by the same value. This then could have the same effect as for the pension above

Ongoing low business income Many people in business who earn low incomes aren't aware that they are entitled to claim tax credits

Mike and Sue – Earn a modest income: Mike and Sue were married, and had no children under 18. They had run a small shop for many years. Despite earning only modest profits, typically £7,640 a year, they had never thought to apply for Tax Credits. After taking professional advice they claimed £4,054 extra cash as Working Tax Credits for the current year. And they also look set to be able to do the same in future years too. Now they wish they had started claiming years ago

Falling business profits – if you are self employed and your business profits fell to £6,420 and you were the only earner, then you would be entitled to a full tax credits claim for the year – in the current economic environment we have advised several clients to register for tax credits in this situation

Peter – Had one year when profits fell: Peter ran a small retail business. He had a bad year and profits dropped well below his normal levels. Because of his previously good profits he had never claimed Tax Credits, and would not have thought to do so now. However, after receiving professional advice, he was able to claim £2,610 in Working Tax Credits, which helped to soften the blow of the fall in profits.

If Peter had been a parent his claim would have been significantly higher still since he would then have also been entitled to Family Tax Credit.

Business losses – business losses can be offset against other income including that of your partner (this isn't allowed for income tax purposes). If they aren't utilised in the current year they can be carried forward to offset against income in future years

Setting up a business, incorporating a business, changing an unincorporated business year end or ceasing a business – all these options will usually present flexibility in planning your tax credits affairs and should be discussed with us as soon as you start to plan such changes – again we have advised clients undergoing these changes

Sarah and John – incorporate: Sarah and John were married with two young children. John had been in partnership with his parents running a garage. They then incorporated the business and capitalised the goodwill, since it lead to significant ongoing tax savings. As a result John now found himself with a directors loan account – ie the new limited company owed him money.

After taking professional advice, instead of paying him a salary, the business paid him the equivalent amount by way of a repayment of his loan account. As a result he was also able to receive an extra £9,552 in cash in the form of Tax Credits.

Thanks to the "income disregard" rules, as long as John's income doesn't go up by more than £25,000 he will receive another £9,552 as Tax Credits next year also. In fact, if certain technical conditions are met, John and Sarah may also continue to receive £9,552 in Tax Credits for quite few years to come.

Director loans used to provide income instead of dividends

Paul and Anne – owed money by their business: Paul and Anne are married with three young children. Paul owns a small building company, and the company owes him £220,000. Normally Paul takes salary of around £6,000 to use up his personal allowance, and a tax efficient dividend of around £20,000 to give him the total of £26,000 a year he needs to live on.

After taking professional advice, instead of the company paying him a £20,000 dividend this year it has paid him a £20,000 repayment of the money it already owes to him. So Paul has received the same amount from the business as normal, but he has also received an extra £9,552 cash from the Tax Credits system.

Once again, the "income disregard" rules mean that as long as Paul's income doesn't go up by more than £25,000 they will receive another £9,552 as Tax Credits next year also. And if certain technical conditions are met, they may also receive that amount of Tax Credits for quite few years to come

Also: Did you know?

• HMRC Tax Enquiries – when HMRC open up an enquiry for income tax, they often open up a tax credit enquiry at the same time (if relevant). It's important to get your tax credits right...
• 70% marginal tax rate – did you know that if you're a basic rate taxpayer, the effective marginal tax rate of a person being paid tax credits is up to 70%, namely income tax, national insurance and tax credits. It's important to get your “Income” figures right, including those for your business...
• Childcare vouchers offered by an employer – these could actually cost you money – contact us to discuss this further

Want to know more? Contact us now.