Company directors can take money out of their limited company in a variety of ways. How you balance the different methods will impact how much tax you have to pay, so there’s a financial incentive to make sure you’re paying yourself in the most efficient way possible.
We’ll go through these different types of payment in this blog post, looking at how you go about obtaining them, and the tax implications of each:
- Director’s loan
Paying yourself a salary
In most cases a salary will not make up the bulk of your income, but there are reasons to make yourself an employee of the company.
A salary gives you a basic level of monthly income that doesn’t depend on the business’s performance. For a lot of directors running startups or small businesses, it’s comforting to have this safety net.
However, be careful not to make your salary too large. If you want to take money out of the company in the most tax efficient way possible, you need to keep the salary within the current personal tax allowance (£11,500).
Although you don’t want to pay income tax if you don’t have to, keeping your salary above the minimum threshold for National Insurance is advisable. This threshold currently stands at £680 per month (£8,160 per year). While National Insurance is a deduction from your salary, paying it gives you additional benefits such as a state pension and maternity allowances.
A salary of between £8,160 and £11,500 isn’t going to stretch very far, so it will need to be supplemented with more tax-efficient ways of taking money from your business.
Taking out a director’s loan
A director’s loan allows you to take money out of your business at any time, though it will need to be paid back. All loan transactions that take place – whether the company owes you or you owe the company – should be recorded in a director’s loan account. This doesn’t have to be a physical bank account, it just needs to keep track of what has been paid and when.
This kind of loan is an effective way to pay yourself a monthly sum on top of your employee salary, but how is that possible when it needs to be repaid? A director’s loan needs to be repaid within 9 months of the end of the financial year, which means that you can use the money you receive from interim or final dividends to pay back what you owe the loan account.
We’ll discuss dividends in more depth in the next section, but it is important to note here that dividends are only awarded after tax and any other expenses have been paid. This means that you should not give yourself a director’s loan based on gross profits, but on the profits that your business has retained after all other expenditures. This will stop you from coming up short when you receive your dividends.
If you want more information on directors loans, take a look at our dedicated blog post.
Taking dividends from company profits
Understanding dividends is essential for working out how to take money from your company in the most efficient way possible. Dividends are taxed less than a standard salary and allow you to take money from the company without having to pay it back, unlike a director’s loan.
Dividends are sums of money that are handed out to company shareholders at the end of a financial period, dividing the total profit (after tax and all other expenditures) however many shareholders there are. Many smaller businesses will only have one or two shareholders, which makes the calculation relatively simple.
Shareholders can receive either interim dividends or final dividends. There are a couple of important distinctions to make between the two. Final dividends are given out at the end of the financial year, once the company’s net profit has been confirmed. The dividends are approved by the shareholders at an annual general meeting (AGM).
Interim dividends, however, can be declared by directors at varying times, often quarterly or every six months, and their payment can be changed or rescinded if necessary. Interim dividends would be based on the company’s performance from the last payment.
Calculating tax on different payment methods
The tax calculation for dividends is fairly straightforward, with different percentages applied to different amounts in a similar way to income tax. The bands are as follows:
- Up to £5,000 tax free.
- £5,001 to £45,000 – 7.5% (basic rate)
- £45,001 to £150,000 – 32.5% (higher rate)
- More than £150,000 – 38.1% (additional rate)
Before paying dividends, the business will also have to pay 20% on their profits as corporation tax.
Thanks to the above tax bands, dividends are much more tax efficient than a regular salary, which is why they are often used to make up the bulk of a director’s income.
There are also cases in which you or the company might have to pay tax on a director’s loan, including a possibility of tax if you are a shareholder as well as the director. Ordinarily, corporation tax of 25% must be paid on the original loan if:
- The loan was over £5,000 and you took out another loan of £5,000 up to 30 days before or after it was repaid. Upon repayment you can claim back the tax, but not interest.
- The loan was over £15,000 and you took out another loan when it was repaid. Tax can again be reclaimed when the original is paid off.
- The loan is not paid back within 9 months of the end of the tax year. The tax can be repaid when you pay back the loan, but not the interest.
All of the above scenarios mean that the loan needs to be recorded on the Company Tax Return.
If the loan is more than £10,000 or is written off at any point, your business needs to deduct National Insurance through the payroll.
Finally, if you paid interest below the official interest rate you need to report the difference on your self assessment tax return, and you may be required to pay the difference back.
Getting the numbers right
There’s a lot of information to take on board when it comes to the tax implications of different payment methods. It is worth seeking the advice of an accountant or tax specialise, particularly if you are just starting out with your own company and you are a director for the first time.
Making a mistake with tax can lead to lengthy investigations and further financial cost, so it’s important to get right. With proper planning, however, you can take money from your limited company without an issue, and start enjoying what you’ve built.