There are three main ways in which money can be drawn from a limited company - repayment of a director's loan, salary and dividends - but there are key issues to understand regarding each of these. It is important to organise the balance of these three items (when they are all available) in order to minimise your tax liability. However, the basic fact will remain - the more profit the company makes, the more tax you are likely to pay. There is no magic scheme for removing all tax liability! The points below outline the main considerations when extracting money from your company.
If you have put your own money into the company, then this is recorded in the director's loan account which totals the money the company owes you. You can draw from this at any time without any tax liability, but you will need to make sure that the cash flow of the business can support this. While it sits in the company you are entitled to charge the company interest. The interest rate is determined by the Board of Directors and should be at a reasonable commercial rate.
The interest you receive must also be declared on your personal tax return as it will be subject to tax. However, if the director's loan account becomes a loan from the company to you, then you need to be careful as you should not owe the company more than £5,000. If you exceed this you must notify HMRC of the loan and pay 25% of the loan account balance. This tax is however refunded as soon as the loan balance is reduced.
Remember that the company is a separate legal individual to you. So it can pay you a salary and, just as would happen in any job, tax and national insurance (NI) must be deducted before you receive your pay. The company also pays 12.8% of the salary in NI contributions and is responsible for paying this and the employee's tax and NI deductions to the Revenue. So, there are significant additional costs in the company paying you a salary.
However, as everyone receives an annual tax personal allowance and there is a further amount of approximately £2,000 that is only taxed at 10%, you can take a salary of, say, £6,500 (up to which point no NI is due) and only pay tax of around £200. You should at least take the annual allowance in salary and preferably the 10% rate band also.
These are a distribution of profits, so it goes without saying that the company must be making a profit before dividends can be paid. If there is no profit then repayment of director's loan and salary are the only routes. The directors decide on the distribution of profits in dividends and must be voted on and minutes drawn up before the year end. Remember that there should be a board resolution with the date of distribution recorded. Dividends are taxed but, at present at least, are not subject to NI, so saving both employers and employees NI payments.
It is important that you grasp the principles but the issues are sometimes complex and we recommend that you take professional advice on these matters. Remember too that governments do change the rules so exercise caution. Remember that a good accountant can advise you of the best way to extract money from your Ltd company.
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