How Do Profit Extraction Schemes work?

Profit Extraction schemes offer profitable trading companies an opportunity to reward key staff (including Directors) in a very tax efficient manner.

Conceptually, most profit extraction schemes are a type of Bonus Pool, ie a sum of money set aside from the business to reward and incentivise potentially any member of staff. Different Service Providers use different "vehicles" to hold the bonus pool. Many of these are Employee Benefit Trusts.

The key legislation for most such vehicles is Sch 24 FA 2003. Most Service Providers seek to arrange their bonus pool such that Sch 24 does not apply to it. If it does apply, then the company would not be able to claim a Corporate Tax Deduction unless and until the employees are taxed on the amounts allocated to them.

If Sch 24 does not apply, then a Corporate Tax deduction may be due under general accounting principles, usually when funds are transferred out of the vehicle, perhaps into key employee sub-trusts.

The accounting treatment is outlined in UITF32. UITF32 states that the assets of the EBT should be included in the company’s balance sheet unless:

- The company can enjoy no future economic benefit from the assets held by the EBT, or

- The company can exercise no “de facto” control over the assets within the EBT.

Hence, funds within the EBT are on the balance sheet of the company, whereas funds within an employee sub-trust are not. The disclosure in the statutory accounts is usually on the basis that a deduction will be claimed in the Profit & Loss account when funds are transferred to the sub-trust.

Once a sub-trust is established and funded, employees can choose when and how to take their funds out of their sub-trust, via an “Expression of Wishes” made to the Trustees. Many employees ask for a loan from their sub-trust as this is particularly tax efficient. Some employees leave the funds within the sub-trust, using it as a tax-efficient wrapper for investment purposes.

Any assets held within an EBT will also be exempt from Inheritance Tax on the death of the relevant employee.

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