Running your own limited company provides greater flexibility over your personal income, specifically on how and when you pay yourself. This enables you to structure your own remuneration in a more tax-efficient way, by taking a director’s salary through PAYE and drawing shareholder dividends at regular intervals, or periodically when company profits allow.
Furthermore, directors’ loans and a variety of employee expenses are available, which can go towards an overall ‘package’ of benefits.
To help you establish the most tax-efficient remuneration structure, we will explain the different options available to you and discuss the various taxes that you will need to pay.
What taxes need to be paid through PAYE?
Salaried directors are taxed at source through HMRC’s Pay As You Earn (PAYE) system, just like any other employee. Income Tax and National Insurance Contributions (NIC) must be deducted through payroll, along with additional employer’s NIC, and paid directly to HMRC.
Wages are a deductible business expense, so your company will not pay Corporation Tax on your director’s salary. Corporation Tax is only charged on profits, i.e., the money that is left over after you’ve paid/accounted for business overheads and other expenses.
In the tax year from 6 April 2022 to 5 April 2023, the standard Personal Allowance (the annual income that an individual can earn tax-free) is £12,570. Income Tax is then applied at the following rates to earnings above that amount:
- 20% (Basic rate) – £12,571 to £50,270
- 40% (Higher rate) – £50,271 to £150,000
- 45% (Additional rate) – Over £150,000
If your adjusted net income is more than £100,000, your Personal Allowance will decrease by £1 for every £2 earned above that figure. This means that your Personal Allowance will be zero if your annual income is £125,140 or above.
You can view current and previous Income Tax rates and Personal Allowances online.
National Insurance Contributions (NIC)
In addition to Income Tax, employees and their employers must make Class 1 National Insurance Contributions on earnings above a certain level.
On your director’s salary, you will pay 13.25% NIC on earnings above £9,880/year (Primary threshold) up to £50,270/year (Upper Earnings Limit). The rate is reduced to 3.25% for any income above the Upper Earnings Limit.
Additionally, your company will have to make employers’ National Insurance Contributions at a standard rate of 15.05% on your salaried income above £9,100 per year (Secondary Threshold).
You can view current and previous NIC rates and thresholds for employees and employers online.
What taxes are paid on dividends?
Directors who receive dividend payments are liable to pay Income Tax on any payments above the £2,000/year Dividend Allowance. The rate of tax will depend on the individual’s income tax bracket. However, the tax rate applied to dividend payments is lower than the equivalents for salary payments, with the current rates as follows:
- £12,571 to £50,270 (Basic rate) – 8.75%
- £50,271 to £150,000 (Higher rate) – 33.75%
- Over £150,000 (Additional rate) – 39.35%
Unlike salaries, paying dividends is not classed as a business expense, so they cannot be deducted from your Corporation Tax bill. Instead, dividends are distributed from profits, which means that companies will have already paid 19% Corporation Tax on that income before it is paid to shareholders. This is the reason for the tax-free Dividend Allowance and lower rates of Dividend Tax.
More information about tax on dividends is available from HMRC online.
What taxes need to be paid on directors’ loans and expenses?
A director’s loan is essentially any money that you take from your company that is not a salary, dividend, or allowable expense. These loans can also work the other way around – by lending money to your company, for example, to buy equipment or to help with temporary cash flow issues.
Whilst such loans must be repaid, they provide an opportunity for tax-free borrowing over the short term.
However, you may have to pay tax if you take a director’s loan: If you’re overdrawn on your director’s loan account at the end of the company’s financial year, there will be what is known as an S455 charge.
S455 tax is calculated as part of the Corporation Tax Return at a rate of 33.75% of the outstanding balance at the company year-end. This charge is payable if the loan account is not cleared within 9 months of the company year-end. Any S455 tax paid will be refunded to you when the director’s loan is repaid. Therefore, S455 is essentially a holding tax.
From a personal tax point of view, HMRC considers a director’s loan in excess of £10,000 as a benefit in kind. If the company does not charge you interest on the loan or charges less than the official rate, HMRC will charge the official rate of interest to calculate the benefit in kind.
For 2022/23, the official rate of interest is 2%. Therefore, if a loan of £10,000 has been outstanding for 12 months, the benefit in kind would be £200.
Expenses come with different tax liabilities, and some are tax-free (e.g. certain childcare costs). Guidance on expenses and benefits for employers is available online.
What is the most tax-efficient way to pay myself?
The most tax-efficient way for a company director to be paid is a combination of a salary (through PAYE) and dividends. Further efficiencies can be gained by availing oneself of tax exemptions and using directors’ loans and expenses where necessary.
The key lies in taking advantage of any personal allowances and tax-free options, whilst at the same time minimising Corporation Tax and legally avoiding other company liabilities where possible.
The most tax-efficient approaches for company directors will vary depending on the specific circumstances and the tax rates and bands for the year, but the basic approach is as follows:
Step 1 – Salary
Multiple directors or companies with more than one employee
In companies with at least two employees, the directors can take a salary (PAYE) of £12,570 and claim the Employment Allowance (see below). This approach will avoid Income Tax liability, whilst at the same time enabling the salary to be deducted from company profits, thus lowering the Corporation Tax bill.
There will be a small amount of NIC to pay (since the Personal Allowance threshold is above the NIC thresholds) both on the employee and employer sides.
Sole directors with no other employees
In companies where there is a single director and no employees, the Employment Allowance cannot be claimed. Therefore, the most tax-efficient approach (for the 2022/23 tax year) will be to take a salary up to the Primary Threshold of £9,880 per annum. It should be noted that this will entail some administration in respect of payment of a small element of employers’ NIC.
An alternative method is to take a salary up to the Secondary Threshold of £9,100 per annum. This will avoid NIC altogether and the ensuing administration, but is marginally less tax efficient.
Please note: While only paying up to the NIC thresholds can be tax-efficient it is not the right thing for everyone. Remember, to get the full state pension on retirement you need to have made a total of 35 qualifying years of National Insurance Contributions or credits.
While you can choose to make voluntary contributions, it is a lot easier to just keep your contributions up to date by making regular payments via PAYE.
So, if someone is anticipating the state pension as being a significant source of income on retirement, it may be preferable to take a salary up to the Income Tax threshold.
Step 2 – Dividend payments
Draw dividend payments of at least £2,000. Beyond the tax-free Dividend Allowance of £2,000, it is best to only take what is necessary and leave the remainder in the business as retained earnings.
The tax paid on dividends will be lower than the tax paid on an equivalent salary. This is because the rates are lower than the corresponding Income Tax rates, and there is no NIC to pay.
Although dividends cannot be declared as a business expense (whereas salaries can), the Corporation Tax and Dividend Tax payable on this money is still lower than the combined rates of Income Tax and NIC.
It is worth remembering that any given person may have other small, or not-so-small investments where dividends are received and are already eating into the £2,000 Dividend Allowance (and bracket of income taxed at 8.75%). So, be careful and check all investments for dividend payments as you may already have used all or part of your tax-free allowance.
Step 3 – Expenses, directors’ loans, pensions, etc
There are a variety of allowable business expenses, and some company owners make substantial use of expenses and benefits on top of their salary and dividends. The expenses and benefits that can be claimed include but are not limited to:
- Pension and retirement benefits schemes
- Computers and office equipment
- Training costs
- Company cars
- Fuel expenses (mileage allowances) and parking charges
- Medical insurance
- Travel expenses, meals, and entertainment costs
There are different taxation and reporting rules depending on the type of expense. An A to Z of expenses and benefits, along with the relevant tax rules and rates, can be viewed at GOV.UK.
Aside from business expenses, there are Income Tax reliefs, which consist of:
- Methods of paying less tax, to take into account money that has been spent on specific things; and
- Ways of reclaiming tax or getting it repaid in another way, such as into a personal pension
Although some of the tax reliefs are automatic, it is necessary to apply for others. Tax reliefs include:
- Pension contributions
- Charity donations
- Maintenance payments
A company director can make use of business funds, for a limited time and without paying any tax, through a director’s loan. However, strict time limits apply. If loans are not repaid on time, Corporation Tax and Income Tax will be levied.
Furthermore, it is not possible to simply keep making the same loan over and over again. This is known as ‘bed and breakfasting’ and will attract tax.
One of the most tax-efficient ways of extracting profits from a business is to put funds into a pension fund. Making pension contributions avoids Corporation Tax, Income Tax and NIC – as long as it falls below the annual allowance for tax-free pension contributions, which is currently £40,000.
Furthermore, if money is taken out of the pension pot (when this is permitted – normally not before the age of 55), 25% of any amount taken is tax-free.
The Employment Allowance is a scheme that allows limited companies – whose employers’ Class 1 National Insurance liabilities were less than £100,000 in the previous tax year – to reduce their annual NICs by up to a maximum of £5,000 each tax year.
It cannot be claimed by companies that (i) have only one employee who is paid above the Class 1 National Insurance secondary threshold and (ii) where that one employee is also a director of the company. In other words, it cannot be claimed by sole directors who work alone.
What this means in terms of tax efficiency is that sole directors with no other employees may want to consider taking a salary of no more than the Primary or Secondary Thresholds (i.e., before NIC kicks in), whereas multiple directors or those with other employees can take up to £12,570 (the maximum Personal Allowance) and then claim the Employment Allowance to offset NIC.
And there you have it.
We have discussed the question – what is the most tax-efficient way to pay myself from my limited company?
It should be stressed that the figures quoted represent the optimal solution from a tax point of view, but they need to be tempered with reality. That is, how much you need to take out of your company to cover your cost of living and how much you feel your hard work is worth.
Regardless of what you decide to pay yourself, I would always recommend you take advice from a professional, such as an accountant or specialist tax advisor, especially when considering tax reliefs and benefits in kind which are complex areas of tax.