Introduction

If you are the director of your own UK limited company and reside in the UK, there are some simple ways to tax efficiently extract company funds that minimises the total tax paid.

This article walks you through what is the most tax efficient way to extract funds for a typical company director – however most people’s circumstances vary and therefore it’s always best to seek professional advice from a Chartered Accountant. While the cost of professional advice may seem like a put off, more often than not it can pay for itself by minimising your ‘overpayment’ to the taxman, not to mention saving you precious admin time!

Basic principle of ‘tax efficiency’

Tax can be paid by yourself as an individual (through salary, taxable company benefits or dividends) but tax can also be paid by your company, through corporation tax. What is important to consider for a typical company director is to minimise the amount of tax paid for both the individual and the company, after all it is the money after both taxes that goes into your pocket.

We have worked out and presented below our advice on what is the best strategy for extracting funds based on minimising the total tax paid for a typical company director.

Methods of extracting company funds

There are four key ways of extracting cash funds from your company and some important restrictions that must be adhered to in doing so. These are as follows:

1. Director’s salary – This is most simply the company paying you for your services in the same way people working for large companies are paid a salary. If your company is paying you any more than £5,668, your Chartered Accountant will need to declare this to HMRC (even if you don’t pay tax!).

2. Dividends – This is where the company distributes allowable profits to shareholders and issues a dividend voucher. There is usually nothing wrong with paying this as frequently as your company pays your salary but your Chartered Accountant must ensure the company has enough profits for this to happen, considering prior year losses and current year profits. Either you or your Chartered Accountant should also think about how much cash your company has to pay other obligations such as Corporation Tax and VAT payments that is paid in arrears.

3. Allowable expenses – These usually relate to expenses wholly and exclusively for the purpose of the business. However, they can include an allocation of expenses between yourself and your company.

4. Director’s loan – This is usually paying back the money owed to you by the company, often lent when you set up the company itself. However it may also be money that you as a Director owes the company (subject to legal restrictions).

Each of the four forms of extracting company funds are outlined below.

1. Director’s salary

If your company is your exclusive source of income we often recommend our clients to pay a salary that:

a) Makes use of your personal allowance that entitles you to pay yourself without incurring income tax.

b) Falls below the point at which your company is required to pay employers national insurance (NI) but is sufficient to be eligible to earn NI credits to entitle you to a full state pension.

For 2013/14, we typically advise our clients to pay no more than £7,692 per year (or £641 per month) per person. If your spouse also works exclusively for the company, you can also make use of your spouse’s personal allowance up to the same amount.

While the limit of £7,692 per person is a guideline maximum salary, it may be more tax efficient for this to be lower if you are claiming tax credits (working tax credits or child tax credits). Unfortunately there is no hard and fast rule here so we have our own in-house tool to consider tax credits in tax planning for our clients.

2. Dividends

If you’re taking the  maximum salary as detailed in (1) and wish to extract more funds from your company then you can pay yourself dividends up to a maximum of £23,318 without paying tax assuming no other income.  Beyond this amount, it can be tax efficient to utilise your Director’s loan account to pay yourself a dividend, smoothing your profile of funds extraction – we discuss this again below.

The great news is if you don’t go beyond your higher rate tax threshold (£32,010 in 2013/14) is there is usually no tax to pay as an individual!

So why is it better to pay dividends than salary between the suggested £7,692 and £32,010 higher rate tax threshold I hear you ask? Let’s compare.

a) If you pay yourself more than £7,692, you’ll need to start paying employees NIC (12%) and your company may need to also pay employers NIC (13.8%). And if you pay yourself more than your personal allowance personal allowance (£9,440 in 2013/14), you’ll also have to pay 20% income tax.

b) If instead you pay dividends after taking the maximum allowable salary in (1), the effective rate of tax for your income is 0%. This does however mean that your company has to pay 20% tax (because dividends aren’t tax deductable for corporation tax) but 20% for your company is much lower than what you pay as an individual.

3. Allowable expenses

 As obvious as it may sound, expenses that are wholly and exclusively associated with the company are allowable expenses and if paid for personally using your own money they are reimbursable in full. However, we often find cases where directors are simply not aware of the ability to claim back certain expenses. Our most common cases are described below:

– Mileage – If you have your own car which you use to travel to visit clients, suppliers or for other purposes exclusively for your business (excluding travel to and from your home to your primary office), you are entitled to claim back mileage at a rate of 45p per mile for the first 10,000 miles wholly from your company. Unless you have a gas guzzler, the mileage allowance exceeds the cost of fuel as it considers wear and tear, insurance and other elements associated with your vehicle.

– Use of home as office – If your primary offices are at your home address or a property owned by you personally, you will be entitled to claim back a proportion of the relevant costs associated with running your home (including utility bills and mortgage interest). The proportion is most easily calculated based on the number of rooms or floor space consumed by your business. It is advisable in these circumstances to have a contract in place.

– Entertainment – If you entertain wholly for purposes associated with your businesss, you are entitled to claim back the cost if paid for personally. Quite often this guidance is confused with restrictions on allowable expenses for corporation tax and therefore these claim backs are not made.

– Costs incurred prior to incorporation – If you incurred costs prior to incorporating your business, such as purchasing stationary or a computer, then you would be entitled to claim these costs back (or in certain circumstances you could resell or even lease these back to your company) so long as they were incurred no longer than 7 years before incorporation. This does not however include the costs of incorporation itself.

4. Director’s loan

Most commonly with a Director’s loan, money is owed to a director such as upon incorporation of a trading business previously undertaken by an individual or if there was a direct cash injection into the company by the director when it was formed (above any share capital issued). In these circumstances, the director would be entitled to pay themselves back tax free. The timing of using this repayment is important – as it can help to reduce your tax burden.

Sometimes, money is owed to the company by the director. There is merit in doing this, for example, if the director requires a cash payment in advance of dividends being issued possibly in order to change the year of recognition of dividends to the next tax year – again reducing the tax burden using timing differences. However, some strict rules need to be adhered to by the director:

– If the loan remains outstanding at the end of the company accounting period, this needs to be declared

– If the loan is not repaid 9 months after the end of the company accounting period then tax charges may apply. Repayment may be in the form of cash, dividends, bonuses, etc.

– If the loan exceeds £5,000 then it is advisable for interest to be paid on this loan to avoid being considered by HMRC as a hidden benefit in kind.

Finding the right mix between these four methods of extracting company funds can be quite complex and therefore it is recommended that this is reviewed on a quarterly basis with your Chartered Accountant to ensure it is tax efficient. Your Chartered Accountant should not only think about your total personal income in that tax year but your expected personal income and company income in order to plan your affairs tax efficiently.  

For all of our new clients, we provide a free tax health check to ensure they are planning their affairs as tax efficiently as possible. If you have concerns about how your affairs are being planned, feel free to get in touch for free, no obligation advice.