Limited companies are individual legal entities, which means that business finances and assets belong to the company, not the owners of the business. As a result, you must follow specific procedures to take money out of a limited company. Below, we explain the different ways that you can do this.
When running a limited company, you cannot simply withdraw funds from your business bank account whenever you want. You must record all income received by the company and all money paid out by the company. You also need to factor in business taxes to determine how much profit is available to withdraw at any given time.
Four ways to take money out of a limited company
The four ways that you can legally take money out of a limited company are:
- as a director’s salary
- as dividend payments
- as a director’s loan
- by claiming allowable expenses
By extracting profits using a combination of these methods, a limited company can be an extremely tax-efficient way to run a business and minimise personal tax and National Insurance liabilities. This is because a company’s taxable income (profits minus costs and overheads) is subject to only 19% Corporation Tax, as opposed to Income Tax of 20-45% that sole traders have to pay.
Income Tax rates for 2020/21 are:
- 20% on taxable income up to £50,000
- 40% on taxable income between £50,001-£150,000
- 45% on taxable income above £150,000
Company directors, many of whom are also shareholders, usually receive a salary from the company. Directors are essentially employees, so the company must register with HMRC for PAYE and pay Employer’s National Insurance Contributions (NIC). The company must deduct Income Tax and Class 1 NIC from the director’s salary and send this money to HMRC on a monthly or quarterly basis.
Salaries and wages are tax-deductible expenses that are paid before the deduction of Corporation Tax. This means that companies do not pay any tax on this money. Directors can pay themselves in a tax-efficient manner by taking a small salary up to the NIC primary threshold (£9,516 for 2020/21) but below the tax-free Personal Allowance limit (£12,500 for 2020/21), then topping up their personal income with dividends.
When a director uses this strategy to take money out of a limited company, they incur no personal tax liability on their salary but they still qualify for state pension and benefit entitlement. Furthermore, they pay dividend tax on their dividends, which are set at much lower rates than Income Tax.
Dividends are sums of money paid to shareholders out of company profits after the deduction of 19% Corporation Tax. Most directors are also shareholders, which means they can take money out of a limited company in the form of dividends.
There is no tax liability on dividends up to £2,000 per year. Above that amount, the following dividend tax rates apply:
- Basic rate: 7.5% up to £50,000 annual income
- Higher rate: 32.5% between £50,001 – £15000 annual income
- Additional rate: 38.1% above £150,000 annual income
Sole traders would pay a great deal more in Income Tax and National Insurance on the same amount of taxable annual income.
Dividend income is taken into account for Income Tax band purposes. When an individual’s annual income exceeds the basic rate threshold, dividend payments are liable to higher and/or additional dividend tax rates, so it is important to be wary of the pitfalls of higher tax rates.
Dividends are only available if a company has retained profit after the deduction of all costs, expenses, and business taxes for the current financial year, and after taking into account any retained profits and losses from previous financial years.
If there is no profit remaining after these considerations, dividends cannot be paid. If any dividend payments are made, they would be deemed illegal and could result in an HMRC investigation and penalties.
How to issue dividends
Limited companies can issue interim dividends on a regular basis throughout the year, or they can issue final dividends at the end of the financial year. Most small companies issue interim dividends because the owners tend to rely on this regular income.
To issue dividends, directors must ‘declare’ them at a board meeting and agree on a payment date. Dividend vouchers (or dividend ‘counterfoils’) should then be issued to shareholders, usually on the date the payments are declared
A dividend voucher is essentially just piece of paper (or an electronic document) that provides the following details:
- company name and registration number
- date the dividend was issued
- shareholder’s name and address
- payment amount
- number and class of shares on which the dividend payment is being issued
- director’s signature
Minutes of the board meeting must be taken, even if a company has only one director. Copies of minutes should be kept at the registered office or SAIL address.
Director’s loans and director’s loan accounts
A director’s loan is another tax-efficient way to take money out of a limited company. The purpose of a director’s loan is to allow a director to borrow money from a company, or a company to borrow money from a director. These transactions must be recorded in a director’s loan account, which can be in the form of a bank account or bookkeeping entry.
A loan account will record a running balance of all money paid to the company by a director or removed from a company by a director. Account balances will show as ‘in credit’, ‘nil’ or ‘overdrawn’, in much the same way as a personal current account with an overdraft facility.
- A director borrows money from a company that exceeds the amount they have given to the company. The loan account will be ‘overdrawn’ until the loan is repaid in full or written off by the company
- A company borrows money from a director. The loan account will be ‘in credit’ until the director reclaims the money they gave to the company
- If no money is owed by a director to the company or by the company to a director, the loan account will have a balance of ‘nil’
There may also be tax implications for a director and a company, depending on the overdrawn balance and the period of time the loan account is overdrawn. If a company owes money to a director, the director can remove this sum from the loan account at any time without facing any tax liabilities.
Tax on director’s loans
All transactions in a directors’ loan account must be accounted for in the company’s balance sheet. These transactions may also have to be included in the Company Tax Return and the director’s Self Assessment tax return. Tax liabilities for overdrawn loan accounts depend on the amount of money a director owes to the company, or vice versa, and the length of time the loan account has been overdrawn.
In most cases, there will be no tax implications for a director if an overdrawn loan account of £10,000 or less is repaid within 9 months and 1 day from the end of the company’s accounting reference date (ARD). If the overdrawn loan is not repaid within that time, the company may have to pay 25% of the outstanding amount as Corporation Tax.
If a director owes a company more than £10,000, this sum must be declared on their Self Assessment tax return. The official rate of interest may be applied. Companies and directors may also charge interest on any sum of money owed to them.
A loan from a company to a director is classed as a ‘benefit in kind’. This means that Class 1 National Insurance must be deducted through payroll. If a company writes off a director’s loan, it is treated as a form of taxable income, so the director will need to pay Income Tax on the loan through Self Assessment.
When a director lends money to a company, they can charge the company interest on the loan amount. If interest is charged, this will count as a business expense for the company and a form of personal income for the director. The director will need to report this interest as income on their Self Assessment tax return. If no interest is charged by the director, the company will have to report the loan on the Company Tax Return.
Leaving surplus profit in a company
The flexibility of a limited company structure allows you to leave surplus income in the business and withdraw in a future financial year. This is a great option if removing this money would result in a higher rates of Income Tax and/or Dividend Tax in the current financial year. There is no such tax-planning strategy available to sole traders.
What tax do company directors pay?
Company directors pay Income Tax and National Insurance Contributions on their total annual income. These deductions are paid directly to HMRC through PAYE (and Self Assessment if the director receives income other than a salary). The company collects Income Tax and Class 1 NIC on a director’s salary through payroll and send it to HMRC, along with the company’s Employers’ National Insurance contributions .
If a director receives part of their income as dividends, no National Insurance is payable on that income. This results in a saving for both the director and the company. If a director is a higher rate taxpayer, they may have to pay a higher rate of tax on any dividends they receive.
Self Assessment for company directors
Directors must register for Self Assessment and report all sources of taxed and untaxed income on a Self Assessment tax return each year. If a director owes more tax than the company has collected through payroll (e.g. from dividend payments and benefits received), the director must pay the additional tax through Self Assessment.
Reporting an overdrawn director’s loan through Self Assessment
There are certain tax implications for directors and limited companies when a loan account remains overdrawn or in credit for a certain period of time. Interest rates are applied in some circumstances.
Companies may be required to include details of directors’ loans in their Company Tax Returns and paying tax under Section 455 of the Corporation Tax Act 2010.
Directors may have to include details of these loans on their Self Assessment tax return. They will also need to pay Income Tax on any loans that have been written off, or on interest they received from the company.
When to report a director’s loan on your Self Assessment tax return
Directors must report loans on their Self Assessment tax returns in the following circumstances:
- The director owes the company more than £10,000 at any time during the year
- The director pays the company interest on a loan below the official rate of interest
- The director is not required to repay the loan because it is ‘written off’ or ‘released’ by the company
- The director charges the company interest on a loan, which is classed as a form of personal income
There are a number of circumstances when a director’s loan and interest payments are viewed by HMRC as forms of taxable income. Therefore, directors will be liable to pay Income Tax and National Insurance Contributions on these loans or payments.
We strongly advise consulting an accountant or tax advisor to assist with matters relating to director’s loans and Self Assessment tax returns, particularly if you have no prior experience with such matters. An accountant can also provide tailored advice and guidance on the most tax-efficient way to take money out of a limited company.