Extracting funds from your limited company

• 9 March 2012

It is important for both tax and legal purposes to understand how you as a director can take money out of your company and in what format.

Here we look at the main options.

1.Salary

There are a number of reasons why some of the amount you take from the company should be in the form of salary. We look at each of these in turn:

1. Taking a salary of £8,105 will ensure that your annual personal allowance for 2012-13 is not wasted.
2. Taking an amount as salary will reduce your profits for tax purposes regardless of whether you actually withdraw the amount or not. Some clients query whether they should take wages in the early years of a company as this may “produce” a loss. This is not necessarily a bad thing – as a loss can be carried forward against future profits subject to certain restrictions and any amount not withdrawn as wages can be shown in the director’s account and taken at a future date when cash flow permits without any further tax consequences.
3. Drawing a salary will also increase the contributions that can be paid into a personal pension.
4. A salary equivalent to £7,485 or higher for 2012 -132 will be regarded as a qualifying year for state pension and benefit entitlement.
5. Salaries can be paid to directors at different rates whereas dividends payable will follow the structure of the company’s shareholdings.

What about the national minimum wage (NMW) ?

Where there is no explicit employment contract between the director and the company, the director is viewed as an officer of the company rather than a worker and so not covered by the NMW legislation.

Be careful here though with family members – if they are not officers of the company, then they will be viewed as workers and must be paid the NMW. They should also be paid a commercial rate for the role they are performing in the business.

2.Draw Down of the Director’s Account

Where sole traders or partnerships have incorporated, it is likely that business assets including goodwill were sold to the new company. This will create an amount due by the company to the directors.

Additionally, if the director’s wages are not actually withdrawn from the company, they can be added to the loan due by the company.

Such amounts can be accumulated and withdrawn by the director without any further tax consequence at a future date when cash flow permits as it is simply a loan being repaid.

This route can be a useful alternative to dividends where funds withdrawn by the director would take him/her into a higher rate tax bracket.

3.Dividends

Used in conjunction with a small salary, this route still offers the most tax effective option with no further tax to pay if salary is taken up to the personal allowance with the remainder as gross dividends up to £42,475.

Dividends also offer the following benefits:

1. The higher rate of dividends for 2012-13 is 32.5% which is lower than the 40% payable on earned income. This is also the case for additional rate payers with the dividend rate of 42.5% compared to 50% on earned income.
2. There is no national insurance to pay on dividends
3. Dividends offer flexibility in when and how much can be paid depending on the success of the business
4. Dividends are paid based on shareholdings. Flexibility in the payment of dividends can be gained by issuing different classes of shares.

There are also important considerations to bear in mind:

1. Dividends are paid after corporation tax (20% as from 01/04/11 for the small company rate)
2. Dividends must be paid out of accounting profits or reserves – this may not be the same amount as the cash made by the business in any one period
3. If dividends are taken by the directors where there are insufficient reserves, these will be viewed as being illegal. In this situation, the directors may be required to repay these amounts to the company
4. Payment of dividends are made to shareholders only – make sure you know who has shares in the business. This is important because a director may not be a share holder. This would mean that any amount paid to him would need to be subject to PAYE and NI. This is one of the first checks that an accountant should do when taking on a new limited company as a client.

Summary

The key is to be aware how much you are taking out and in what format. This is particularly important close to the end of the tax year where you need to be careful in approving and paying dividends which take shareholders into a higher band of tax. This can be avoided by simply waiting a few days until 5^th April.

Keep your accountant up to date with your plans and check that you are being tax efficient, as once payments are made, you cannot retrospectively go back and “change” their nature.