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Strategies for extracting profits from owner-managed business

One of the benefits of running your own business is that you have the freedom to decide how much of the profits should remain in the company and how much should be returned to you as an owner (shareholder). However, with that also comes one of the most classical tax-planning questions we are often asked:  how do I get money out of my company in the most tax-efficient way?

The modes of profit extraction are a handful - each with its own merits and tax implications - unfortunately, many entrepreneurs are insufficiently advised or do not thoroughly grasp the principles of how to effectively apply them. In these series of articles we shall explore the following strategies for drawing funds from your business, analyse the likely financial implications to you, and your company and evaluate their tax effectiveness:
  • Salaries and bonuses
  • Benefits in kind
  • Director’s remuneration
  • Pension contributions
  • Dividends
  • Selling assets to the company
  • Charging rent on personally owned property used by the business
  • Charging interest on loans to the company
  • Loans or advances from the company
  • Liquidation of the company

Should surplus profits be retained or extracted and how much should be drawn out?

Aside from legal and tax considerations, which we shall mention later, your personal financial needs and those of your business will be the primary factors in determining how much to extract and how much to reinvest in the business. Needless to say, in order to grow your business, you need to invest in it and not less important than that, you as individual need money to maintain your lifestyle.  Finding the balance is an art rather than a strict formula and requires careful assessment of your current circumstances and future plans, business and personal.

On the legal side, declaration and payment of dividends are regulated by the Articles of your company, which in turn is subject to the Cyprus Companies Law Cap.113 statutory provisions and rules on capital maintenance related to payment of dividends. One of those fundamental rules is that dividends can be distributed only out of profits. Therefore, even if your business is cash positive you will not be able to pay yourself dividends if there no profits; however, you may employ other methods such as paying yourself a salary or receiving repayment of a loan previously given to the company.

Although there is no statutory requirement forcing companies to distribute dividends, the Cyprus tax legislation imposes "deemed dividend distribution", whereby, companies are considered to have distributed to their Cyprus-tax-resident shareholders, 70% of their after-tax accounting profits, as at the end of the second year from the year in which the profit was made. This "notional dividend", outlined in Art.3(3) of the Special Defence Contribution Law 117(I)/2002, is then taxed 15% in the hands of the Cyprus-tax-resident shareholder. To illustrate that, let’s say your business made an after-tax accounting profit in 2009 and paid only 50% of it in dividends. The 20% undistributed profits of 2009 will be deemed to have been distributed at the end of 2011 (if not fully paid by then) and you, as a shareholder will be levied with 15% special defence contribution.

The deemed dividend distribution serves a dual purpose to the Cyprus state; first, it ensures that there is a steady inflow from taxing individuals receiving dividend income, and second, circumvents the excessive accumulation of profits and thereby the capital appreciation of the shares, which if sold will not give rise to any tax.

In summary, business and personal factors will determine how much to pay yourself for doing a good job at your company; however, it will be the legal and tax aspects that will define the possible and tax-efficient ways of doing that. It is also important to recognise that lack of financial and tax planning may force you to unknowingly or unwillingly take a mode of profit extraction that has an overall high tax cost or prevents your company from taking a good business opportunity.
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Quantia Advisors Ltd is a firm of Certified Public Accountants approved and registered to carry on accounting and audit work in Cyprus. Details about our statutory audit and general practice accreditations can be viewed at the Institute of Certified Public Accountants of Cyprus (ICPAC) under reference E264/A/2013 and E264/G/2013, respectively.

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