Cashflow

Company directors: What is the most tax efficient way to take money out of your business?

We're often asked by company directors as their financial year-end approaches: “How can I take money out of my business in the most tax efficient way?” The answer is: it depends! In this article, we outline each option - salary and expenses, as a dividend, and to an extent, as a director’s loan - along with the personal tax and corporation tax implications of each option.

One of the most common questions we’re asked by company directors as their company approaches its financial year-end is:

“How can I take money out of my business in the most tax efficient way?”

The answer is: it depends!

As a company director, there are a few options available to you to take money out of your business: as salary and expenses, as a dividend, and to an extent, as a director’s loan. We outline each of these options below.

Each of these methods for taking money out of the business has its own personal tax and corporation tax implications. And if you choose to combine the methods for extracting money out of your business, the personal tax and corporation tax calculations can be even more complex.

That’s why, as your company year-end approaches, we recommend that you seek advice from our tax and accounting experts about your current financial position and the most tax-efficient way to take money out of your business. Ensuring that you are making full use of the allowances to which you’re entitled, but also considering the corporation and personal tax implications of each option.

Please note: In this guide we assume that the company director is also a shareholder in the company but this is not always the case. If you are a director but not a shareholder, the rules around taking money out of the business, and the implications on your company tax and personal tax are different.

Director’s Salary and Expenses

VAT Image

Just like your employees, most company directors pay themselves a salary via PAYE, on which income tax and National Insurance contributions may have to be paid.

Typically, directors will only take a small salary out of the business, usually up to the National Insurance primary threshold of £12,570 per year (for 2023/24).

This means that the director will not normally have to pay income tax or National Insurance Contributions on this salary.

If possible a director will usually take a salary over the lower earnings limit of £6,396 per year (2023/24) as this will mean that they qualify for the state pension and other benefit entitlements.

Like your employees, company directors can also claim for any business expenses throughout the year.

Dividends

Outsourced Payroll

Dividends are a tax-efficient way of taking money out of a limited company.

Dividends are paid from profits retained in the company after corporation tax has been deducted and are paid to shareholders. This is often referred to as ‘distributable profits’.

Dividends can only be paid if the company has sufficient profits. If there are not sufficient profits and a dividend is paid, this may be classed as an unlawful dividend and the shareholders may become personally liable to repay the money.

Currently (in March 2024), the tax-free dividend allowance is £1000 (for financial year 23/24). This will be reduced to £500 for the next tax year (24/25).

This means that a shareholder who receives over £1,000 in dividend income in the tax year to 5 April 2024 will be liable to pay tax on the excess.

In March 2024, for dividend income up to £12,570 (the personal allowance), the dividend tax rate is 0%, for dividend income between £12,571 – £50,270, the rate is 8.75%, for £50,271 to £125,139, the dividend tax rate is 33.75% and over £125,140 the dividend tax rate is 39.35%.

Dividend payments must be declared, and a payment date agreed at a Board Meeting. The minutes of this board meeting should be kept, in case HMRC choose to question the legality of the dividend distribution.

Because corporation tax must be deducted from the company’s profits before arriving at a figure for distributable profit, its essential that the company’s accounts are as accurate and up to date as possible, so professional guidance is advisable.

One key aspect to consider is that when assessing your overall income – to determine which tax band you fall into – your dividend income will always sit on top of all other forms of income.

So as a director/shareholder, if your income consists of salary, dividends, and bank interest, then your dividend income will face the highest tax bands, as it is always the last form of income used in the tax calculation.

But remember, you don’t have to pay National Insurance contributions on your dividend payments. That’s why, to be tax efficient, most directors, who are also shareholders, will pay themselves a small salary, topped up with dividends.

Director’s Loan

Pound Coins

Another way for a director to take money out of their limited company is through a ‘Director’s Loan’. Strictly speaking, this isn’t classed as remuneration but a legitimate way for directors to meet short-term cashflow needs if their business is cash rich and the cash is needed personally for any reason.

Through a director’s loan, a director can borrow money from their company or lend money to the company from their personal funds.

All loans to and from the company by a director must be recorded in a director’s loan account (DLA). The DLA should record any cash withdrawals from the company that you’ve made as a director and any personal expenses which were paid with company money or company credit cards.

If a company has more than one director, each director must have their own DLA.

Putting money into your company

If you lend money to your company, then the company does not need to pay corporation tax on that money.

You can withdraw the full amount from the company at any time, tax free and assuming the company can afford to repay you.

You can charge interest on any money you lend the company, the company will class this as an expense, and you will have to declare the interest as income on your self-assessment tax return and pay the necessary personal tax.

Taking money out of your company

It’s important to note that a limited company is classed as a separate legal entity from its directors, so the company’s money belongs to the company, and not the directors.

Any money you take out of the business belongs to the company and is effectively a loan to you personally.

This loan hasn’t been subject to either company tax or personal tax so eventually HMRC will want to get what it’s owed.

To take a loan of £10,000 or more, a director should get approval from the company’s shareholders. When the director is also the company’s main or sole shareholder, this is a formality, but the decision must still be recorded.

If a director borrows more money than they have put in, then the director’s loan account is overdrawn, and the director owes the company money.

The company can charge interest to the director on their loan account but depending on the individual’s circumstance and interest rates, it may not be appropriate to charge interest.

At the end of the financial year, the balance of the director’s loan account is recorded in the company’s balance sheet, either as an asset – if the loan account is overdrawn (money owed to the Company by the director) or as a liability – if the account is in credit (money owed to the director by the company).

What if the Director’s Loan Account is Overdrawn?

If the director’s loan account is overdrawn at the end of the financial year, then there could be tax implications for the Director and the company.

As a director, you have 9 months and 1 day after your company’s accounting period year-end to pay the entire balance of your director’s loan account if you want to avoid paying tax.

i. Corporation Tax

If you don’t repay the entire balance of the director’s loan account in 9 months and 1 day after the year-end, the company (in 2023/24) may incur additional Corporation Tax (‘section 455 tax’) at a rate of 33.75%.

The corporation tax is paid on either the year-end balance or the amount outstanding after the nine months – whichever is lower.

This additional corporation tax is repayable to the company by HMRC when the loan is settled by the director.

ii. Additional Income/Dividends

If after 9 months and 1 day you – the director – do not repay the loan, and the loan is written off by the company, then you will have to pay tax on the loan.

You will need to include the written off loan on your annual Self-Assessment tax return and the income tax must be paid personally. The tax rate will depend on the individual’s circumstance (director/shareholder) and other income.

iii. Benefit in Kind – National Insurance Implications

What’s more, an overdrawn director’s loan account can also be considered a reportable benefit in kind if the director owes the company more than £10,000 (interest-free) at any given time.

The director will have to declare the benefit in kind at the end of the tax year on Form P11D.

If the directors loan account is overdrawn, the company must pay employers National Insurance at 13.8% on any benefit in kind provided, including the director’s loan.

If the company hasn’t written off the loan to the director and no interest is charged, the director will have to include it as a benefit in kind.

The employer would submit a Form P11D – deadline is 6th July – the director would then include the information found on the P11D(b) on their self-assessment tax return for that relevant year.

Bed and Breakfasting

You cannot use your director’s loan account as a way to avoid paying tax.

For example, you cannot take money out of your company, repay this borrowed money just before the year-end to avoid s455 corporation tax, and then immediately take the money back out again. This is known as ‘bed and breakfasting’ as is seen by HMRC as a way to avoid tax.

When a loan in excess of £10,000 is repaid by a director, the director cannot take another loan over this amount within 30 days. If this does happen, HMRC will take the view that the director does not intend to pay back the loan, and the full amount will be subject to tax.

HMRC will monitor director’s loan accounts through your company’s annual tax return.

Director’s Loans – Seek Advice!

Director’s loans are a legitimate way for directors to extract money from the business, but the rules around withdrawals and repayments are quite complex, with tax implications for the company and also the individual directors.

As we’ve outlined above, if a DLA is overdrawn, there could be additional Corporation Tax and Benefits in Kind considerations for the company. And directors also need to consider the personal tax implications of taking a loan from the company. You should regularly review your DLA position and seek tax planning advice if necessary.

Our advice is to think carefully before taking money out of your company through a director’s loan.

You should have a clear plan to repay the money owed, you should also consider the timings around repaying the loan, and if you have any questions or concerns, always seek advice from your accountant.

Contact Leonherman

If you are a company director and your year-end is approaching, or if you have any questions about the most tax efficient way to take money out of your business, we urge you to speak to our accounting and tax experts without delay.

Call us on 0161 249 5040 or email: partners@leonherman.co.uk and we would be happy to help.

Important Disclaimer

This material is published for client information. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. No responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by Leonherman.

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