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Whilst sole traders generally pay themselves directly out of any business profits, there are more options available to the owners of limited companies. This creates greater opportunities for tax efficiency and planning.
As well as being able to pay themselves like employees through PAYE, a company shareholder (who may also be the sole director and owner, particularly in smaller companies) can also, or alternatively, draw dividends.
Furthermore, directors loans are available, as are a variety of employee expenses, all of which can go towards an overall ‘package’ of benefits. We will take a look at some of these options of paying oneself from a limited company below.
Taking a salary from a limited company
Company owners of SMEs will often be directors as well as employees. Just as any other employee in the business, company directors can draw a regular monthly salary through the Pay As You Earn (PAYE) system.
Salaries are counted as allowable business expenses, so the payment of salaries has the effect of reducing the amount of corporation tax payable. However, paying a high salary can be less tax efficient than drawing dividends (see below).
Registering for PAYE
If they have not already done so, company directors must first register as an employer with HM Revenue and Customs (HMRC) to draw a salary. This is the case even if there is just a single director who also owns the company.
PAYE registration should generally take place before the first payment, and not more than two months before this first payment.
To process any salary payments before an employer PAYE reference number has been obtained, it is necessary to:
- Run payroll
- Store full payment submission
- Send a late full payment submission to HMRC
Limited companies (with between one and nine directors) can register for PAYE here. Rapid Formations includes PAYE registration in our All Inclusive Package or it can be added to any other company formation package as an additional service on the checkout page.
What taxes need to be paid under PAYE?
Salaried directors will be taxed at source, through the PAYE system, just as any other employee. Income tax and National Insurance contributions (NICs) must be deducted, along with additional employer’s NICs, and paid to HMRC.
Some directors opt to limit their salaries to the NIC threshold, or the personal allowance (i.e. Income Tax threshold), and to draw further payments via dividends, for the purposes of tax efficiency.
The latest National Insurance rates for employees and employers are available from GOV.UK, along with Income Tax rates and the personal allowance for the 2023/24 tax year.
Claiming expenses and benefits from a limited company
Some business owners will decide to make substantial use of expenses and benefits, as an addition or alternative to salary and dividends. There are a whole variety of expenses and benefits which may be claimed by company directors, including but not limited to:
- Pension and retirement benefits schemes
- Computers and office equipment
- Training costs
- Company cars
- Fuel expenses and parking charges
- Medical insurance
- Travel expenses, meals and entertainment costs
There are different taxation and reporting rules depending on the type of expense. A full list of expenses and benefits, along with the relevant tax rules and rates can be viewed at GOV.UK: Expenses and benefits a to z.
What tax needs to be paid on expenses?
Each type of expense or benefit is subject to a different amount of tax and some are tax free (e.g. certain childcare expenses*). Taxes on employee benefits should be reported to HMRC where necessary and paid accordingly under PAYE.
* The following forms of ’employer provided childcare’ are exempt from tax and NICs and do not need to be shown on form P11D:
- places made available in a nursery provided by the employer
- other qualifying or directly contracted childcare up to the exempt amount for the employee
- childcare vouchers that can be exchanged for qualifying childcare up to the exempt amount
How is tax paid on expenses?
Taxes on expenses can be paid as part of the PAYE system, on a monthly basis, together with the payment of salaries.
Additionally, employers must send HMRC details of any expenses and benefits which have been provided to employees or company directors (and their family or household), in the form of an end-of-year expenses and benefits report.
Form P11D needs to be filed for each director or relevant employee who has received expenses or benefits; it can be filled in and submitted online. This must be done by 6 July following the end of each tax year.
For more information on completing form P11D, see GOV.UK: How to complete forms p11d and p11db.
Record keeping of expenses and benefits
It is vital that full records of any benefits and expenses paid to directors and employees are retained for 3 years from the end of the tax year to which they related.
HMRC may request to see these records as part of an inspection. Records retained should include:
- date and details of every expense or benefit which has been provided
- any information needed to work out the amounts which appeared on end-of-year (P11D) forms
- any payment contributed by directors or employees to an expense or benefit
Any correspondence with HMRC in relation to benefits and expenses should also be retained.
Drawing dividends from a limited company
SMEs often have a single shareholder who also acts as sole director and essentially owns and controls the entire company.
In this scenario, or where there are just a small number of company owners with equal rights, it will often be more tax efficient to pay out dividends as opposed to full salaries via PAYE (although a combination of the two can be most effective).
What is a dividend?
A dividend is essentially a payment made to company shareholders out of profits. They generally need to be made equally to all shareholders, on the basis of the proportion of shares held.
Dividend payments cannot exceed company profits from current and previous financial years.
How are dividends paid out?
A directors’ meeting must be held to ‘declare’ the dividend payment and minutes of the meeting must be retained – even in the case of a sole director.
In respect of each dividend payment made, a dividend voucher must be written up and include:
- the company name
- date of dividend payment
- names of shareholder(s) being paid a dividend
- the total amount of dividend being paid out
Copies of this voucher must be given to each recipient and also retained for company records.
What is the tax on dividend payments?
There is no corporation tax levied on dividend payments. However, they do not count as business expenses and therefore cannot be deducted from the corporation tax bill.
Shareholders who receive dividend payments are liable to pay tax on any payment above £1,000 received in 2023/24. The rate of tax will depend on the individual’s income tax bracket. However, the tax rate applied to dividend payments is lower than that for salary payments, with the current rates as follows:
Salary: 20% (basic rate) 40% (higher rate) 45% (additional rate)
Dividend: 8.75% (basic) 33.75% (higher) 39.35% (additional)
Unlike sole traders whose personal and business finances are generally fluid and interchangeable, limited companies must follow a strict process when money is taken out of the business by an owner/director. Other than through salary, expenses or dividend payments, one method of making business funds available for personal use is via a director’s loan.
A director’s loan is not considered to be a payment in the same way as salary or dividends, but it is crucial that accurate records are retained, as director’s loans are subject to their own tax rules. These records are known as a ‘director’s loan account’.
What tax must be paid on directors’ loans?
At the end of each financial year, any money owed to the company as part of the director’s loan account must be included, as part of the annual accounts, in the balance sheet. Taxes which apply to director’s loans comprise:
- Corporation tax – if the loan is over £10,000 and is not repaid within 9 months of the end of the relevant Corporation Tax accounting period.
- Personal tax – if the director’s loan is over £10,000. Note: if interest has been paid below the official rate, additional tax may be due.
What is a benefit in kind?
If any asset belonging to the business is used by a company director for their own personal use, this is known as a ‘benefit in kind’ and must be declared for tax purposes. Should a director’s loan account exceed £10,000, it will automatically be classed as a benefit in kind and needs to be reported on the director’s self assessment tax return.
Bed and breakfasting
Although corporation tax is generally payable on director’s loans, if it is repaid within 9 months of the end of the relevant corporation tax accounting period, corporation tax can be avoided (through tax relief). However, the amount still needs to be declared.
If a director’s loan is repaid within the 9 month period, but is immediately taken out again, this is known as ‘bed and breakfasting’. HMRC will view this as an attempt to circumvent tax and will deny tax relief in respect of any loans over £5,000 which are repaid and then taken out again within 30 days.