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Many contractors choose to become directors of their own limited company as it can be more tax efficient than working through an umbrella company or setting up as a sole trader. Being the director of your own company could enable you to maximise take-home pay and take advantage of savings due to the different options available.
There are a few different ways to pay yourself through your limited company, and the method which you choose will depend on your circumstances. To make the process simple and easy, we’ve broken down all you need to know about the different avenues available.
Since your limited company is a separate legal entity, all of its assets belong to the business rather than its owner. This means that you cannot just take money from your business like you would your personal business account. There are specific procedures which need to be followed and any money going in and out of your business bank account must be accounted for.
There are four ways which you can withdraw money from your company’s account into your own:
Taking a salary from your business bank to your personal account is a straightforward process. It’s unlikely that the majority of your income will come from a salary, but it can be a useful method to provide yourself with a monthly pay packet. In order to pay yourself via a salary, your company must first be registered with HMRC. You will be required to deduct all tax and National Insurance contributions and Employers National Insurance Contributions. This is paid directly to HMRC on either a monthly or quarterly basis. HMRC will also require monthly submissions to confirm this salary information.
The personal allowance is currently set at £12,500. This means, providing you have no other relevant income within the tax year, you can draw a salary up to this amount without the need to pay income tax.
Once your company makes a profit, it will need to pay a percentage as corporation tax, but whatever is left can be paid to directors and shareholders in the form of dividends. Dividends are a way of dividing up the company’s profits and distributing them to directors and shareholders as a percentage based on the proportion of the company they own.
Limited companies can issue dividends at the end of the financial year, and at points throughout the year, which is common when the directors or shareholders rely on the dividends for income.
The company directors must declare dividends and a payment date agreed at a board meeting after which, the shareholders should be issued with a dividend certificate. This procedure should be followed fully even if the company only has one director.
Dividends are usually more tax efficient than paying yourself a salary, which is why most business directors choose them to make up the majority of their income.
You can find more information in our guide to dividends.
A director’s loan allows you (as the director) or a family member to either lend money from the business, or from the business to borrow money from your own funds. This loan needs to be repaid to your business account within nine months of the end of the financial year to avoid an additional repayable tax charge (S455 charge). If your business is new, it can be helpful to pay a small loan to help with things like startup costs.
The tax liabilities and any interest payable concerning loans depend on the balance and the length of time for which the account is overdrawn. If the company owes money to a director, then that sum can be withdrawn at any time without incurring any tax liabilities. All transactions must be recorded in a director’s loan account. At the end of the financial year, this record must also be recorded on the balance sheet of your annual accounts.
If you are a company shareholder as well as director, you may have to pay tax on your director’s loans owed to the company.
Any cost that you have incurred personally which has been made ‘wholly and exclusively’ for the purpose of your business can be claimed as a legitimate business cost. Therefore, not only will your business receive tax relief on these expenses, but you will also be able to reimburse yourself personally for the cost.
These costs typically include business miles, insurance and equipment but can include any cost which was necessary. Although business expenses will not make up a large portion of your overall take-home pay, this is an additional and tax-free method which many directors find useful.
For more information about claiming the cost of expenses and to find out what is classed as a business cost, visit our expenses hub.
With so many different options available, it’s not always easy to know what the best way to take money out of your company is. Many contractors find that paying themselves a combination of salary and dividends is the most tax efficient way of operating. This will depend on your business and your personal needs. Having a dedicated accountant can take the stress of tax planning away, as we can advise on a tailored salary and dividend combination to withdraw from your company.
You can find out more about the differences between paying yourself a salary versus dividends in our comprehensive guide.