These are challenging times for small business owners. Many companies are still feeling the shockwaves of the credit crunch and yet they are having to face an ever-increasing tax burden. Furthermore, 2009 Budget's introduction of a super tax rate of 50% is effecting entrepreneurs.

With spiraling income tax rates, together with the hefty National Insurance Contributions rates, owner-managers will be looking to reappraise the most tax efficient ways of taking income from their companies.

Profits available for extraction
Typically, the owner-manager will pay himself or herself a basic salary and provide appropriate tax efficient benefits. After this most discussions about profit extraction usually start by focusing on the amount available to be paid out to owner-managers as their ‘proprietorial reward'.

This can be influenced by such factors as the owner-manager's personal spending and saving requirements, their personal tax position and the amount required for future retention in the business - to satisfy future working capital or capital investment purposes.

Bonuses or dividends?
The two main methods for extracting surplus profits are bonuses and dividends - each having different tax costs for the company and the owner-manager.

For most business owners, and particularly where their company pays tax at the small companies rate, dividends have tended to be a more tax efficient way of taking ‘surplus' profits out of the company. For the current tax year a dividend of £100,000 will incur a personal tax cost of £25,000. Many consider this to be very reasonable tax rate to pay. It's also important to bear in mind that dividends do not attract National Insurance Contributions (NIC) and are not subject to PAYE. This often means that the tax on the dividend is not payable until 31 January following the tax year in which the dividend is paid.

Making savings
An entrepreneur owns all the shares in his company and during the year ending 31 March 2010, he draws a 'reasonable' salary of £40,000. He anticipates that the company will have ‘surplus' profits of £100,000, which could be paid out to him either as a bonus or dividend. The company is expected to pay corporation tax for the year at the small companies' rate of 21%.

If a company has profits of £100,000 to pay out to its owner, they would receive net cash of approximately £59,250 if this was paid as a dividend compared with only some £52,300 with a bonus payment. Some owner-managers may be tempted to extract their income entirely in the form of dividends, but it is often sensible to extract a reasonable level of salary.

While dividends are often preferred, there will be some cases where it is better to pay a bonus - particularly where the owner-manager wishes to obtain tax relief on substantial personal pension contributions. However, for very high earners (those with taxable income levels above £130,000), pension tax relief might now be restricted under new antiforestalling restrictions.

Super-tax rates
The 2009 Budget announced a supertax rate of 50% to those with income exceeding the £150,000 tax bracket. There is a corresponding increase in the top rate of dividend tax. Thus, where a company manager has dividend income falling within the £150,000 plus tax bracket, it will be taxed at 42.5%.

This equates to an effective rate of 36.1% of the cash dividend. Dividends falling within the higher rate band (between the basic rate threshold and £150,000) will continue to be taxed at 32.5% - corresponding to an effective rate of 25% on the net dividend payment, as for the current year.

Many successful owner-managers are likely to be affected by the new super dividend tax rate of 36.1% on the cash dividend payment. Where the company requires the ‘advance' dividend or bonus monies for working capital, the owner-manager can lend them back to the company. The ‘loan-back' could be made at a commercial rate of interest - which might also be a tax efficient way of extracting funds from the company.

Income-splitting and spouses' dividends
Following its defeat in the landmark Arctic Systems case in 2007, many feared that HMRC would be quick to impose legislation to pounce on so-called incomesplitting practices between married couples in owner-managed businesses. Income splitting is the term often used to describe the arrangements for providing dividend income to the wife to benefit from her personal allowance and lower tax bands.

However, the government have confirmed that it currently has no plans to introduce legislation to counter such planning. Therefore, the payment of tax-efficient dividends to, for example, a wife remains effective provided it is properly structured - for instance, the wife must be given ordinary shares in the company with full voting rights. It is possible for a wife to receive a dividend of up to £39,400 in the current tax year without paying any further income tax. It is worth noting that if this dividend has been received by her husband instead, it would have attracted tax of around £10,000.

Many successful owner-managers will certainly bear a lot of the pain inflicted by a government looking to find ways of increasing its severely depleted coffers. However, business owners still have a number of ‘acceptable' tax planning strategies open to them, which can bring useful tax savings.