Strategies for extracting profits from owner-managed companies: Salaries and bonuses

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One of the strategies to extract profits from owner-managed company is through employment income (salary, bonuses etc.). To begin with, this strategy is applicable to those who participate in the day-to-day running of the business in the position of employee or executive directors. Since the company and you are separate entities, you will need to sign an employment contract, de facto becoming employee of your company. In setting your employment contract keep in mind that the minimum salary in Cyprus required by law is: €835 per month at entry and increased to €887 per month after six months of employment.

Business implications
In addition to paying emoluments (net of 6.8% social insurance and PAYE), the company will incur the following employment-related contribution costs:
6.8% – social insurance
2.0% – social cohesion
1.2% – redundancy
0.5% – industrial training (HRD)
8.0% – holiday fund

If the company offers annual vacation term better then the one stipulated in the Annual Leave with Payment Law 8/1967 - 20 days for employees working 5 days a week, and 24 days for employees working 6 days a week - than it can apply to the Director of Social Insurance requesting not to pay contributions to the Holiday fund.

Contributions, when Holiday fund exemptions has been granted, are calculated on the basis of insurable earnings, covering almost all types emoluments and subject to an upper limit, which essentially is stepped up every year with the rate of inflation. Except for the social cohesion, which is not subject to the upper limit, there is not liability to both, the employer and the employee, to pay contribution on the excess amount. For 2011, the maximum yearly amount of insurable earnings is €52,104 (€4,342 per month).

Personal implications
As an employee or executive director, there will be two withholdings from your employment income: one remitted to the Department of Social Insurance and the other to the Inland Revenue Department (IRD). The first withholding is 6.8% social insurance contribution and the second, pay-as-you-earn (PAYE) personal income tax calculated based on the progressive tax rates after allowing tax deductions (one of which is social insurance). So, if you gross annual employment income is  €20,923 you will incur 6.8% social insurance cost (€1,423) per year but pay no income tax since your taxable earnings will be below €19,500.

In addition, being on the payroll of your company and making social insurance contributions will make available to you all benefits and grants of the social insurance scheme (old age pension, unemployment, maternity etc.) as well as participation to your company’s provident fund, to name a few.

Tax effectiveness
In essence, the company will bear an additional cost of 10.5% (or 18.5% if not exempt from Holiday fund) on payments to its employees but also reduce its taxable income with the amounts paid to the various funds except that for the social cohesion fund, which is disallowed expense for tax purposes. On the other hand, you as an employee of your business will pay 6.8% in social insurance and income tax on anything above €20,923.

Assuming that the company has opted out of the Holiday fund, the minimum combined (company and owner) total social insurance and after-tax cost is 17.3%. This is somewhat expensive strategy if not combined with other options but also unavoidable because if you are employed in the business you must receive salary. If you do not have remuneration but work for your company, it is very likely that the Director of Social Insurance will impose such and you will have to pay contributions.

Finally, in most cases it is beneficial to have your spouse brought into the business as director or employee (full or part-time) and pay remuneration provided that the spouse’s marginal tax rate is lower than yours. It is usually recommended, that the remuneration be paid into a separate bank account on the sole name of the spouse instead into a joint account. Notwithstanding that, tax inspectors will most likely scrutinise remuneration paid to any family members to ensure that they are paid at market rate. If the remuneration is unreasonably high for the position and work performed, the excess will most likely be disallowed as business expenditure.

Tags: tax strategies