A limited company is a legal ‘person’ in its own right, which means that it’s financially independent of its directors and shareholders. In addition to being responsible for its own debts and liabilities, the money that a company receives belongs to the business itself, not the owners of the company. As a result, certain rules and restrictions apply to the way in which you can withdraw money and pay yourself through a limited company.
The most common and tax-efficient form of remuneration is a combination of a director’s salary and dividend payments from shares. This strategy is possible if you are both a director and a shareholder of your company, which is commonplace for most small company owners.
Directors are classed as employees; shareholders are classed as investors. This means that any person who is a director and shareholder of their own company can pay themselves a regular director’s salary and then top up their income with dividend payments.
Directors’ salaries are an allowable business expense, so they are paid before Corporation Tax is calculated on company profits. To pay yourself a director’s salary, you will need to register your company as an employer and operate PAYE (Pay As You Earn) as part of your payroll.
You can arrange for an annual salary to be paid through PAYE at regular intervals, such as weekly, fortnightly, or monthly. The company will then deduct Income Tax and Class 1 National Insurance contributions (NIC) from your earnings, which HMRC will collect through PAYE. The company will also pay Employers’ National Insurance on your salary.
Some directors choose to keep their salaries below the Primary Threshold (PT) for NIC, which is £184 per week/ £797 per month/ £9,568 per year for the 2021-22 tax year. This results in no Income Tax or Class 1 NIC being deducted from the salary.
Another popular option is to take a salary above the PT but below the tax-free Personal Allowance, which is currently £12,570. This results in no Income Tax deductions but a small amount of NIC, ensuring that the director is making eligible contributions toward their State Pension and benefits entitlement.
You can, however, pay yourself any size of salary that you wish, provided that the company can afford it. Indeed, many directors feel that it is more ethical to pay themselves a larger salary and take smaller dividends only when the company has significant profits.
Paying Income Tax and NICs on a director’s salary
If you live in England, Wales, or Northern Ireland, you will pay the following rates of Income Tax on your director’s salary:
- Personal Allowance: 0% on annual income up to £12,570
- Basic rate: 20% between £12,571 – £50,270
- Higher rate: 40% between £50,271 – £150,000
- Additional rate: 45% above £150,000
If you live in Scotland, you will pay the following rates of Scottish Income Tax on your director’s salary:
- Personal Allowance rate: 0% on annual income up to £12,570
- Starter rate: 19% between £12,571 – £14,667
- Basic rate: 20% between £14,668 – £25,296
- Intermediate rate: 21% between £25,297 – £43,662
- Higher rate: 41% between £43,663 – £150,000
- Top rate: 46% above £150,000
Please note: You will not get a Personal Allowance if your annual income is £125,000 or more. This is because your Personal Allowance will decrease by £1 for every £2 of adjusted net income above £100,000.
The Class 1 National Insurance contributions (NICs) that you will pay on a director’s salary are:
- 12% on earnings above the Primary Threshold up to and including the Upper Earnings Limit (£967 per week/ £4,189 per month/ £50,270 per year)
- 2% on the balance of your earnings above the Upper Earnings Limit
The company will also pay 13.8% Employers’ National Insurance on your director’s salary income above the Secondary Threshold (ST), which is currently £170 per week (£737 per month/ £8,840 per year).
Dividends are paid to shareholders from limited company profits after 19% Corporation Tax has been deducted. Unlike salaries, they cannot be counted as a business expense. This means that you can only issue dividends if the company has remaining profits after the deduction of Corporation Tax.
If there is no surplus income after running costs, salaries and wages, and business taxes have been deducted, you cannot pay yourself dividends.
Given that a company’s profits will fluctuate, you can choose to issue dividends on a fixed schedule like salary payments, or on an ad hoc basis when the company has sufficient surplus cash to justify dividends.
Many company owners choose to reinvest at least some of their trading profits in the business, rather than taking it all as dividend payments. It is also sometimes beneficial to leave surplus cash in the company until a future tax year, for example, to avoid going into a higher Income Tax band.
A common misconception is that dividend income is tax free. This is incorrect. Whilst shareholders do get a £2,000 tax-free Dividend Allowance, they are legally required to pay Dividend Tax on annual dividend income above that amount. This must be reported each year on a Self Assessment tax return.
Dividend income above £2,000 is subject to the following Dividend Tax rates, which are based on your Income Tax band:
- 7.5% if you are a Basic-rate taxpayer
- 32.5% if you are a Higher-rate taxpayer
- 38.1% if you are an Additional-rate taxpayer
To work out how much Dividend Tax you need to pay, you must calculate your total annual income from all sources, including your director’s salary, dividend payments, and any other taxable income you receive. Depending on how much you earn in a tax year, you may not have any Dividend Tax to pay, or you may have to pay one or more of the above rates.
Please note: Dividend Tax does not apply to dividends from shares in an ISA.
Directors can also withdraw money out of a company by way of a director’s loan. This applies when you take money from the company that is not:
- your director’s salary
- dividend payments
- reimbursement of expenses
- money that you have already paid into the company
- money that you have loaned to the company
Any money you lend to the company, or borrow from the company as a director’s loan, must be recorded in a director’s loan account. Both you and the company may be required to pay tax on a director’s loan, depending on whether it is overdrawn (you owe money to the company) or in credit (the company owes you money).