Minimizing decision making

By Ken on April 23, 2011

How many decisions do we have to make each day? 10, 50 or even a hundred? If you add up the subconscious decisions we are forced to make, it might be beyond the thousands. Basically, it is good to be in a position in which you are allowed to make decisions. You have options and you are the person to decide. It is supposed to mean “freedom”. But, is it truly freedom? Does it make a difference whether I can choose to have the extra-chunky tomato sauce or the quattro-formaggi type of taste in my mouth when I am too tired to cook properly and just want to eat SOMETHING? Did I ever think like “Wow, I am so happy that I took the BBQ-chicken-taste pringles out of the rack because that moment changed my life”? Nä, not really. Is it supposed to be like that? No either. That’s good because it tells me that I am doing nothing wrong. So, I make a decision for the sake of decision making and not because I think that the gusto of BBQ-chicken pringles will change my culinary perception or because I think that BBQ-chicken does reflect my personality more properly than onion-flavored generic brands. Potato-chips do not represent me and I don’t want to be represented by my potato-chips. I can say: I have a fairly healthy horizontal relationship with my potato-chips and I am happy about it.

In other words: I don’t care. I don’t want to spend time to think about potato-chips, or the lunch-menu or anything that is not important to me. I want to pareto my decision making and I am sure that the ratio of modern decision making efficiency is not 80/20 but rather something like 99.99/0.01. So, why not making the decision to not make a decision when it comes to the 99.99 in daily life? That decision might be the 0.01. I started to not make decisions when it comes to eating. I am not allergic to anything and I eat almost anything and I have never met anyone who eats something that I am not comfortable eating myself. Therefore, if anyone asks me “Hey Ken, what do you wanna’ eat?” my answer is “I’ll have what you’ll have.” It seems that my answer confuses people. Suddenly they feel responsible and ask me questions like “Do you feel like eating pizza?”. It seems like the decision to not make a decision shifted the burden of decision making on other people around me and now I see that they are stressed because of it. I will continue this and I am looking forward to the day where someone says to me “Ken, be a man and choose your own food!”.

I think the problem is that we always want the best for ourselves. Options provide us the chance to find the best for us. However, as perfection is the enemy of the good, sometimes we should go along with the “good enough”. My friends choosing my meal is good enough for me. I trust them and sometimes I get to eat something that I wouldn’t have chosen in the first place. Thanks guys.

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How to turn annoying phone calls into fun.. for yourself and others.

By Ken on November 18, 2010

Last post I wrote about how much I get annoyed when other people talk on the phone in trains. But how can you turn this into fun? … Actually, I’m a bit stuck. I thought about many ways to make this fun when I wrote the post last time. But, it seems that I have forgotten them all in the last couple of days and now I don’t know what to write. So, let me shortly write down the few things that I can still remember.

  • Address the other person with “Mr. President”, “Your majesty” (only initially, after that it’s “ma’am” , “Your honorable judge”, “His holiness” or simply “Capt’n”.
  • Speak different lingo: Talking like a pirate can be quite entertaining. You find basic information on ‘how to talk like a pirate’ on www.talklikeapirate.com. The following video teaches you the basics too.

… and the others I forgot. Sorry for that.

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Here is the reason why people talking on the phone in public are annoying

By Ken on November 12, 2010

Am I the only one who really hates when someone is constantly talking on the phone at 7 am in the train? These people are not even trying to lower their voice. Not only that, it’s also too much info. They talk about stuff as they would when they are in private. I would be ashamed if I knew that someone hears me talking like that. However, interestingly, it doesn’t annoy me as much when two people are talking directly to each other in the train. But how come?

The reason for this stress we feel, when some stranger is talking on the phone in a public but temporarily closed environment, is our subconscious. I remember once reading an article about psychology which explained this phenomenon (sorry, no reference here). Our subconscious tries to guess what the other person on the other line might have said, based on the talk we hear. This process is extremely complex and thus stress for us because of two reasons. First, you have to listen and analyze at the same time, i.e. there is a time lag. Consider the following conversation:

1: “Honey, did you already buy some milk?”

2: “(this is the part you don’t hear)”

3: “Ah, okay. Fine, then I’ll get some lettuce.. btw. what did Steve say about next weekend?”

Here you have to find out by yourself, that “honey” must have bought already some milk, but forgot to buy the lettuce. So the answer to the initial question “did you buy milk?” is not answered in sentence two (which would have been in a normal conversation), but in sentence three after you did the work of analyzing that sentence. Now you have the information to fill in the empty space of sentence two. So the conversation is linear, but not to you. Your mind goes nuts hopping from one sentence to another. It goes back and forth. Additionally, sentence three already contains the question “what did Steve say?”, which must be also processed to make sense in sentence five. As you can imagine, this whole process requires a lot of energy and attention.

The second reason is: you are left in the dark. You’ll never get the confirmation whether your guess was right or not. You are simply unsure whether you interpreted the conversation correctly. We assume that the duration of silence, i.e. how long the other person talks, correlates to the complexity of the unknown answer. The longer we don’t get information, the more cognitive work our brains have to do, since we assume that the time is related to the amount of information transmitted (in reality it isn’t). Additionally, the fact that the person is a stranger makes this process even more onerous. My thoughts could have been something like this:

1: “Honey, did you already buy some milk?”

“Who is Honey? Did she buy the milk? .. no, ‘already’. He was planning to go grocery shopping but also knew that there was a chance that she did that already. Is it a problem when they have two packages of milk at home? No, it must cost him some extra effort to go buy the milk, otherwise he wouldn’t call. At least the cost of going to the grocery store must be equal or bigger than the cost of calling her.

3: “Ah, okay. Fine, then I’ll get some lettuce.. btw. what did Steve say about next weekend?”

“Ah, good. Apparently she got the milk, but must have forgotten the lettuce. Salad? btw? Who is Steve and what is the connection between lettuce and Steve? What might ‘honey’ have asked Steve and what was his response? …

… and so on. Not only do we have to process these complex strings of thought, but we must also interpret other cues that person provides us: gender, age, clothing, gesture, tone of voice etc… But, we are and never will be sure about that. This is the difference to a friend talking on the phone next to you. You know him or her, probably also who the caller is and his connection to your friend. Simply you know that person well enough to interpret the conversation correctly, while listening only half of it.

People talking in the train are annoying because a) your subconscious works hard in order to compensate the lack of information and b) you don’t know whether the outcome of that is correct. That leads to stress. Consider these ‘people talking in trains on the phone’ as broken windows… that might be another blog post. However, other people talking on the phone in the train annoys me and I see it as an anti-social behavior. I try not to do it for the sake of peaceful commuting.

In the next post, I will tell you how you can turn this into extreme fun!

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What are your broken windows?

By Ken on November 9, 2010

I’m a big fan of the broken windows theory. The theory states that our environment has an impact on our social (or anti-social) behavior. First introduced by Wilson and Kelling, the broken windows theory received a lot of attention nearly three decades ago. The theoretical explanation is that, if you have a building with broken windows, which do not get repaired over time, the chances are high that it attracts vandals to break even more windows. This is because it sends a message that such things, as for example broken windows are accepted in that specific environment. The theory suggest to fix these windows quickly in order to avoid serious crime.

I see broken windows figuratively everywhere. One piece of paper evolves into a huge pile of papers. One short E-Mail I didn’t reply to, turns into an inbox with E-Mails dating back almost a year (“yeah, I’ll answer the mail when I have some time”). A blog that hasn’t been updated for month. You get it.

But why do I like the broken windows theory? I like it because it taught me how important small and incremental changes are. That not tolerating broken windows in life, can have a huge impact in the long-run and this idea is applicable almost in any part of life. Ramit Sethi mentions often enough how effective these small little things are in personal finance, which become nothing more than habits over time. A poet once said: “If you wanna make the world a better place, take a look at yourself and make that change”. I think that change is easier than we think. It is as easy as fixing some broken windows. But the difficult part is to identify these as such. Clutter you didn’t get rid of. The one pound you gained in weight. The small amount of debt you took to finance some unimportant stuff. Friends you didn’t drop a line once in a while because your were so busy. The time where I didn’t talk with my partner, because I didn’t want to make a fuss out of it. These are all little things. Just some small broken windows. But we know that you don’t become a hoarder, obese, broke, friendless or divorced over night. These broken windows create the environment that allow such things. What are your broken windows?

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No no no, I did it again

By Ken on May 27, 2010

First I thought: “Yeah, I’ll write next weekend. There I have plenty of time to…”, then I thought: “Yes, I should…but.” A couple of days later it became “Oh, yes. I knew there was something I wanted to do.” and now it’s like: “Ken, didn’t you have a blog or something?”. My blog went comatose. Again! Maybe I am just lacking the passion to write about taxes. I mean it would be kind of nerdy if I would say that I have a passion for taxation. I find it very interesting, but maybe not interesting enough to write a couple of articles every week. So what to do now? I don’t know. I’ll just continue writing and we’ll see what the main topic of this blog is going to be.

While my blog went directly into a coma, my girlfriends blog, which she started just for fun in late february, attracts now around 100 visitors a day. There is so much I can learn from her.

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The only person on earth who decides whether you save money or not is: YOU!

By Ken on March 11, 2010

Recently, I wrote why the prospective gain of “saving money” should not influence your decision making process. In essence, I am the opinion that you should not buy a house to save on taxes or that you should not eat a low-fat burger to lower your calorie intake. But why does the “and save money” argument influence us so much?

Let’s consider this scenario. You pass by your local gas station and see the following price information:

  • Cash – € 1,30 per liter
  • Credit – € 1,35 per liter

The product this gas station offers is the same, but the difference in price is due to the method of payment. From a business perspective, this can be totally legit, since the owner of the gas station has to pay a certain fee to process credit card payments. This information can be interpreted in two different ways. This pricing is either a penalty to the customer who wants to pay with plastic, or it is a reward to the customer who pays cash. But how you interpret this information depends on your own expectations regarding payment methods at gas stations. If you are more used to paying with your credit card, you will probably say “Hey, thats unfair!”. But if you use cash anyway, you’ll probably say “Hey, nice!”. It is either a gain or loss of 5 cent, depending on your personal expectation what the default should be. It also depends on the default price you have in mind. If you think that € 1,30 is the normal price, you consider credit payment as a penalty. But if you think that € 1,35 is the normal price, you would see the cash payment as a discount. Whether loss or gain depends on your perspective.

In other words, you are not able to determine whether the 5 cent difference is a discount or a penalty from the information above. You need an anchor price, something that tells you what the price should be. Nobel-prize winning psychologist Daniel Kahneman and his colleague Amos Tversky call this the “framing” effect (Kahneman and Tversky, 1984: “Choices, Values and Frames” American Psychologist, 39, p. 341-350).

In case your frame for gasoline prices is € 1,35, the 5 cent would represent a discount. If your price is € 1,30 there is no benefit for you when you pay in cash and a penalty if you want to pay with credit. But if your reference price is  € 1,25, even the cash alternative becomes a rip-off.

In case of gasoline prices this all is not a big deal. Prices are usually transparent and you can easily find a reference price. But what about other products? Think about complex products that do not solely compete on price. How do you determine the reference price for a dinner at a restaurant, a vacation, college education or plastic surgery? Is the offer you have been made a discount or a penalty? How do you know? Before we answer that question, I would like to discuss the thing I refer to as the power of legitimacy.

The Power of Legitimacy

We human beings have the tendency to attribute a huge chunk of legitimacy to things as soon as it is written on paper or stated as a fact. Take a piece of paper, write down “out of service”, stick it on the elevator door and observe. You will not believe how much confusion this will generate. Some people will see the sign and immediately head to the stairs, others will wait in front of the elevator, hoping that the elevator will magically repair itself just in that moment. Some people will push the button and that will create even more confusion because the apparently kaputt elevator seems to work fine. “Maybe it will stuck halfway and I have to stay in the elevator the whole weekend with the accounting guy from the 13th floor with greasy hair and I’ll miss Janes’ birthday party and her awesome sisters, just because I didn’t read the sign, which someone nice put it up to warn me!… I’ll take the stairs”. It is just a piece paper, but we believe what is written. While only 55% of American people vote, nearly 98% check out of their hotel room before 13:00 hrs. You know why? Because that’s what the little sign in the room says: “Checkout until 13:00″. We have the habit not to argue about something that is written down on a piece of paper.

Framing your perception with the power of legitimacy

Let’s get back to the gas station example. Consider you are the owner of the gas station and you can write an additional line above this price information. We assume that you are completely indifferent whether customers pay cash or with credit and that your 5 cent surcharge covers all expenses involving the credit card transactions. Further we assume that you don’t know what the customers’ reference price is. What would you write? Would you write that your business rewards people who pay cash, or would you write that your business penalizes people who pay with a credit card? I guess it is obvious that you would choose something like “Pay cash and save 5 cents per liter!” over “Pay not in cash and we charge you an extra 5 cent per liter!”. But why would you do that?

The reason for that is that the gain of 5 cents seems more appealing to customers than the possible loss of 5 cents. In other words, the negative emotional feelings resulting from a loss of 5 cents have a higher impact on you than the positive emotional feelings resulting from a 5 cent gain. This area of study is called prospect theory. This theory tells us that we perceive the impact of losses bigger than the impact of gains. In other words, we are loss averse.

Keeping that in mind, you want to put something on your sign that is perceived as more favorable by your customers, even though you don’t know their reference price. Once it is written down on a sign, the power of legitimacy steps in: “Pay cash and save 5 cents per liter!”. There, it’s written: “I save 5 cents per liter!” is what we say, because.. ehm… jup, the sign says so.

You are the one who decides

No matter what you buy, keep in mind that whether you save money or pay a surcharge depends on “your” reference price and not what the business owner has put on his sign. There is a chance that I buy something that you might consider as highly overpriced, but which I see as a bargain. There is nothing wrong with that. That only says that we “frame” the price of the product in a different way. However, a marketing slogan that says “Book a vacation with XYZ and save money” is a bold move, keeping in mind that they don’t have the slightest idea what my reference price is. It is similar to saying “Buy our product because its better”. Better than what?

So, if you hear the “and save money” argument the next time, think about your reference price. Don’t fall for the power of legitimacy and take the fact as granted. You are the one who decides whether you save money or not. Not the person who is trying to sell something to you.

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Why a flat tax system is not as simple as it seems to be

By Ken on March 5, 2010

Flat tax systems are often discusses these days. The aim of flat tax systems is to simplify and substitute current tax systems, which nobody fully understands. Even tax professionals, who should understand taxation, do not know everything about taxes. (If you ever meet a guy who claims to know everything about taxes, you should slowly move towards the door, maintain eye-contact and never ever turn your back towards that person. You don’t want to show your back to someone who knows everything about taxes.) Corporate taxation, taxation of individuals, direct and indirect taxation, inheritance tax, sales tax, interest, capital gains, property tax… and there are many many more. Yes, tax systems are complex.

The aim of a flat tax system is to simplify such tax codes so that everyone can understand it. However, it is difficult to realize such system and here is why:

Flat tax system 101

Let’s say there is country A, which implements a very simple flat tax system. The only tax that is levied in this country is a tax on consumption. Think of something like a sales tax or VAT. Every time you purchase something you pay 90% tax. The number is arbitrary, but considering that all other taxes are dropped, that tax rate must be quite high. Let’s assume that such a tax rate is enough to secure the tax revenue that keeps country A running. This is very simple but what are the consequences?

Consequences of a consumption based flat tax system

If consumption is taxed, people who consume less pay less tax than people who consume more. That seems unfair. However, it is your choice whether to consume or not. But you must consume in order to live. So high consumption households (big families for example) face a higher tax burden than singles. In other words, frugal people benefit more than individuals with lavish spending habits. If people realize that frugality is rewarded they will try to minimize consumption and country As’ citizens will become famous for being frugal. They start producing their own vegetables in their backyard, in order to avoid taxation. Maybe they engage in barter and swap chickens for cucumbers, coffee for milk and so on. But this would only happen in a single country environment (Besides the fact that this is a clear backward development of an economy nobody wants). But we’re not living in such a single country world. We have neighboring countries and borders, which we are allowed to cross. What would you do in such a situation?

People will try to shift consumption to other places where it is taxed less. You realize that country B taxes consumption at a lower rate. Therefore, you start buying your groceries in country B, while earning your income in country A. Maybe you decide to move near the border, because that makes life easier and more profitable. On the other hand, people from country B realize that income in country A is not taxed. So they try to generate income in country A. Maybe they are not willing to move, but they start investing in country A because the capital gain is not taxed over there.

You see that such dramatic change in a tax systems shifts the incentive of the citizens and that can have a severe economic impact.

Flat tax on income

Let’s consider a slightly more complex flat tax system, where all income is taxed at a flat tax rate of 25%, no matter how much you earn. Country B does not introduce such flat tax and decides to tax its’ citizens with normal progression. The citizens of country A, who earn less than €Xk (this is the amount where the two lines cross each other) are in a less advantageous situation, since their income is taxed at a higher rate than before (the grey shaded are). On the other hand, taxpayers who earn more than €Xk benefit from this tax system since their income is taxed lower than before (the red shaded area). This would mean that low income earners have now an incentive to move out of country A, while high income earners prefer to become a citizen of country A.

Country B will definitely not like such move of country A and starts to think about doing something nasty to country A. This represents basic tax competition between two jurisdictions. A change in a countries’ tax system affects other foreign economies and that leads to a conflict between the jurisdictions. Country A doesn’t want that, so they cannot change the tax law dramatically.

Therefore, a flat tax might be a very promising idea to simplify national tax systems, but if you take a look at the consequences you see that there is much more to take into account than a simple tax rate. Today, taxation is not only a national matter anymore. A flat tax changes the rules of the game and this can only be done successfully if all players agree. Similar to bar-hopping with 20 people: Finding the location where everyone is happy is not an easy task.

What was your first impression when you heard something about “flat tax” systems? Did you like it? If such a system leads to tax competition, why not? Do you think countries should compete over tax revenue?

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Basic Transfer Pricing 101

By Ken on February 28, 2010

* This is an article which has been posted on gunther goes tax’ish on June 22, 2009 by the author *

“Writing my thesis”, yes. That is currently my answer to the small-talk question “So, what do you do?”. Some people have the courage to ask further, whereby I can see their fear in their eyes of getting pulled into some academic delirium, me starting to explain what I am writing about. The worst part in that scenario: They asked the question. So, the situation often looks like this:

Person A: “So, what do you do?”

Me: “Thanks for asking! I am currently writing my master thesis.”

Person A: “Ah.. Interesting (the face expression always tells: NOT!). What are you writing about?”

Me: “I’m writing about Transfer Pricing issues on intellectual property, with special regard to Art. 7, Art. 9 and Art. 12 of the OECD Model Convention, in the pharmaceutical industry specialized in developing medicine for brain farts.” (Actually, “Transfer Pricing” would be enough for an answer, but I learned that stating the topic as complex as possible discourages people to ask further questions. It is also important to speak a bit faster than at normal speed; it makes it even more complex.)

Thesis topics are not made for small talk. But after reading this, you will understand what transfer pricing is. Transfer Pricing (TP) 101:

TP 101

This is the scenario: There is ManuCo, a manufacturing company in country A, and SalesCo, a sales company in country B. Both companies belong to the same company group. Thus, they are friends and are willing to cooperate. ManuCo manufactures a product and SalesCo is responsible for selling the product in country B. Please have a look at the “Normal Scenario”. ManuCo has costs of goods sold (Cogs) of 80 (this is the cost to produce the product, raw materials etc.) and sells the product to SalesCo for 80. SalesCo buys the product for 80 from ManuCo, therefore their Cogs is equal to 80. Again, SalesCo is able to sell the product for 100 to the end consumer. This leaves both companies with a gross margin of 20. Each company has operating expenses (e.g. utilities, advertising, administration etc.). Subtracting these from the gross margin leaves them with a net margin of 10 and 5, respectively. Since both companies operate in different countries, different tax rates are applicable. Country A wants to have 40% of the EBIT from ManuCo and country B wants to have only 20% of the EBIT of SalesCo. So, both companies pay their respective taxes (4 and 1). Total tax paid is equal to 5 (aka. total tax burden).

Now let’s have a look at the second scenario. Here, the price ManuCo charges SalesCo for the product is 70. Respectively, the Cogs of SalesCo is now also 70. But operating expenses and tax rates remain the same. You also see, that the total EBIT of both companies do also not change (i.e. 15). Now, ManuCo do not have to pay any taxes, since they do not have a profit at all. SalesCo pays 20% taxes on 15 of income, which is equal to 3. You see, that in this case the total tax burden is less than in the previous scenario (i.e. 3 < 5).

What happend? The companies have paid less taxes in total, because they were able to shift profits to the low tax jurisdiction. This is known as “base shifting”. What made it possible to shift the base? The transfer price. The transfer price is the price charged by ManuCo to SalesCo for the product (i.e. 70 and 80). Depending on how the transfer price is set, companies have the opportunity to shift income to low tax jurisdictions. Please note, that ManuCo would not have charged 70 in case they were not friends with SalesCo. Thus, this is only limited to companies within corporate group structures. I hope this gave you some idea what transfer pricing is about.

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Spend money to save money? One paradox in marketing psychology

By Ken on February 27, 2010

Yesterday, I was listening to the radio while driving and there was a commercial that caught my attention: “Book a vacation with XYZ now and save money!”. The more I think about this, the more I don’t get it. I can understand that some people like vacations and that other people like saving money. But both at the same time? It sounds like a miracle.

“and save money” is unrelated to the decision making process

What does this marketing slogan do? It encourages to take action (“book a vacation”), while providing you an additional reason (“to save money”) to do so. The problem is that these two are completely unrelated to each other, at least to me. Why should I book a vacation to save money? Either I book a vacation because I want to have a nice vacation, or I save money because I want to save money. But saving money will never become the goal of “booking a vacation”. You will never hear someone saying “..oh yes, glad you asked. I became a millionaire because I booked thousands of vacations with XYZ”. This is similar to the catch-phrase “Eat the diet burger and save calories”. Your primary aim is not to reduce your calorie intake, it is to eat because you are hungry. How much calories you are willing to consume is another decision you have to make, after you have decided to eat something. Not before. Thus, this additional argument in the slogan tries to bypass your decision making process, whether you want a vacation or not.

You don’t save, you spend

The value of this additional argument depends on the target audience. In case you already decided to book a vacation the price might play a role. Then, the argument “book with XYZ now and save money” seems to be more relevant. Once you decided to book a vacation, other factors will play a role. Price, for example. XYZ is probably stating that their products are cheaper than the ones offered by the competition. Thus, XYZ says that you’ll save some money. However that is quite untrue. You don’t save money, but you simply spend less. There is no “gain” taking place. Similar to sunk costs, which should not influence your decision making, such “sunk savings” should not influence your decision making either. I know that this marketing strategy is highly effective and they are behind every corner waiting there to ambush my wallet. However, if you hear the words “… and save money” related to a purchase, there should be some bells ringing in your head.

The most dangerous “and save money” situation

The biggest purchase people make, while rationalizing that they can save money, is a home. When you google “benefits of being a homeowner”, there is no site that doesn’t tell you that you can save a great amount of money on taxes (actually only 8 out of 10 of the first hits mentioned tax benefits, I checked them). I am not saying that homeownership cannot lead to certain tax benefits. They often do provide such. However, this is the point where it gets risky. The “and save money” argument can distract you from your initial goal and the consequence is that you can make a stupid financial move. Similar to the vacation and burger example: saving taxes must not be a reason to purchase a home. If you want to save taxes, you should save taxes and not buy a home. If you want to loose weight, you should loose weight and not eat a diet burger, right?

As such, the “and save money” argument is highly effective in distracting you from the initial decision making process. Be aware of that and look at the substance. You want to save money? Then save money. You want a nice vacation? Get yourself one. The form should not define the substance. It must be the other way around.

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How to get money out of your company

By Ken on February 24, 2010

Generally speaking, there are three different ways to get money out of your company. You can either be employed, receive dividends or sell the shares you own. However, there are a couple of things you want to consider before taking action. Let’s have a look at each option.

Become an employee of your company

This method is quite straight forward. You sign a contract and you’ll receive a fixed income from employment. Your salary is taxed according to the domestic rules and the tax rate is determined based on the tax bracket you’re in. This can be somewhere around 42% if you hit the highest bracket. Your monthly income tax is withheld at the source (i.e. employer). Let’s say you would receive 100k each year, that would mean 58k in your pocket.

Receive dividends from your company

This is another way to receive payments from your company. The income you’ll receive from dividends is also taxed at approximately 20%. This sounds really good and if you have already expected the *bling-bling* 80k in your pocket I have to disappoint you. Because your pocket money will be only 60k. But how come? Different to employee salaries, which are deductible costs for corporations, dividend payments are not paid out of pre-tax money. Therefore, your money is first taxed at corporate level at a rate which is approximately 25% and then taxed again as passive income in your hands. The dividends you receive are taxed at 20%. The result is that your 100k becomes 75k (100k*(1-0,25), after corporate tax) and again 60k (75k*(1-0,20), after personal income tax). The numbers might be slightly different in each tax system and there are a few countries that have different systems. But the rationale behind this is that your income should be taxed roughly the same in total. Why should someone, who receives income from employment, be taxed at a higher rate? The 20% tax on dividend income sounds attractive, but it must be mentioned that that money has been already taxed by the authorities. Therefore, this method might not be attractive for individual business owners.

Sell your shares of your company

This is another way to extract money out of your company, but there are also some tax implication you want to keep in mind. The tax that applies here is the tax on capital gains (i.e. the tax only regarding the gained proportion of the capital). Let’s say you invested 10k into your company and over time your company value increased to 100k. In order to extract that 100k, you sell your share to another guy. That income minus the initial investment is determined as capital gain. Thus, 90k (100k-10k) will be taxed at approximately 30%. This results in 73k (90*(1-0,30)+10k) cash in your hand. However, you have to keep in mind that in such situation you have sold your business, which is not the case in the previous two examples.

So, what does this all mean?

My personal conclusion is: No matter what you do, there is no “jackpot” strategy. If you want to turn your companys’ money into your personal money, there are really low chances that you can dodge taxation. The tax rates chosen in the previous examples are arbitrary and depending on the jurisdiction they might differ slightly. It is possible that one method has an advantage over the other. But the tax savings are likely to be marginal at best.

So, what can I do?

First of all, you should ask yourself the question: Why do I want to get the money out of my company? The chances are high that you want to spend that money. Buy some nice stuff, fancy dinner, gorgeous holiday trip or a nice home. Whatever you want, you name it. That means that extracting money from your company is not the final goal, but spending that money to get something you want becomes the primary aim, right? That shifts the question and the new question becomes “How can I use my company to buy me some nice stuff without paying lots of taxes?”. That is much more specific. Let’s consider you want to buy yourself a fine nice home and your company has 200k in cash.

Your company belongs to you and you can do whatever your want, right? So, let’s say that the management team (i.e. you and your dog*) decides to rent another office space because you need it. Check out the doodle.

Let’s say you own a holding company, which again holds 100% of the shares in two different companies. One is the company you already had (Corp.) and the other one is a company you started to buy yourself a home (RE). RE is a real estate management company and its business activities are the buying and selling of immovable property and the management of assets which are held by the company. RE takes care of the maintenance of homes, which they rent to individuals to generate revenue. RE receives a 200k loan @ 5% interest rate from your holding company, which is used by RE to buy a home. Corp, your initial business, wants to rent another office space and finds that RE is renting out property. The management team find, that the property of RE is a good location for the CEO to work and decide to rent that space. This will be the fine nice home in which you are going to move in. However, Corp would never pay you a home, so you must work there and within an instant it becomes a home office. Corp pays RE a monthly rent of 1k (12k annually). RE pays with that money the 10k interest to the holding and the remaining 2k are paid for property taxes, insurance and maintenance costs. Everything is deductible since these expenditures are necessary to operate the business of RE. Similar to that, Corp is able to deduct the rent, since it is used as office space (Which business can properly function without an office, huh?).

So, what do you get?

First, you get a home which is owned by your company. But that doesn’t mean anything, since you can decorate it they way you want and make it nice and cozy. Although, you might have to work a couple of hours at home, since it is considered as office space from a tax perspective. Second, you don’t have to pay insurance, interest, property taxes and maintenance from your individual after-tax money. This would have been the case if you had bought the house by yourself. RE can deduct these costs as business expenses. However, RE does not make any profit, since payments from Corp are set the way that RE does not make any profit at all. Corp on the other hand is able to deduct the rent payment, since the new home is considered to be a rented office space.

What does this tell me?

I would like to mention here that this is a really simplified model and I am not sure whether this is legally possible or not (please read the disclaimer). However, this back-of-the-envelope style model tells me two things.

First, it’s more important to understand why you want to do certain things, rather than how to do them. Extracting money from your company is not a big issue. But the proper method changes, if you know why you do it. You want money for a nice vacation: Why not set up a business meeting on Hawaii? You want a car: Why not become sales manager of your company and use it as a business vehicle? I don’t know how much of this stuff is possible (Your VC will not like the idea of you, driving around a Maserati) and it depends a lot on other circumstances (But I guess that your accountant, tax advisor and corporate lawyer can help you out). Why do you want to extract money? Make sure that you can answer this question first. Once you have an answer, try to find a way backwards that makes that specific goal real.

Second, ownership is nothing and access is everything. What is the benefit of claiming “ownership” of something if you can have access to it for a much lower price. Take books as an example: Why do you have to own a book, if you can get access to all books at your library down the street for free? I believe that there is some kind of magic with “owning stuff”. I do like to own certain books and gadgets too. However, we must keep in mind that access is sometimes a better choice than ownership, as it has been illustrated in the example above. As such, ownership is the “form” while access is the “substance”.

* A friend of mine, working as a real estate agent, used this technique when he dealt with clients. When the client made him an offer he said that he had to call his “partner”, who was his dog. If the dog said “no”, which he didn’t, the client was told that “the partner didn’t agree”. This made it easier for him to deny offers (what can you do if your partner says no?) and he was able to play dumb (“I’m not in the position to make such decisions. I gotta ask my partner.”) and thus gave him some time to rethink the deal (Sorry, my partner is currently in a very important meeting; i.e. my dog is taking a crap in the backyard).

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