Running a limited company offers various advantages, one of which is the ability to decide when and how to pay yourself. This is a significant benefit compared to being a sole trader, where you are taxed on profits as they come in. Let’s explore the best ways to balance salary and dividends, as well as other strategies to get the most out of your limited company.

Balancing Salary and Dividends

For the 2024/25 tax year, the general advice for owner-managers is to take a salary of £12,570, with the rest of their income coming from dividends. Here’s why this approach is beneficial:

Tax Efficiency: With a salary of £12,570, no income tax or National Insurance Contributions (NICs) are payable, provided the full personal allowance is available. This salary also counts towards your state pension.

Dividends: Dividends are typically taxed at lower rates than salary. Therefore, after taking a minimal salary, paying yourself in dividends can be more tax-efficient.

Higher Salary Considerations

Sometimes, a higher salary might be necessary for personal or business reasons. If your salary exceeds £12,570:

NICs: You will pay 8% NICs on earnings between £12,571 and £50,270 and 2% on earnings above this. 

Employer’s NICs: Employers also pay NICs at 13.8% on earnings over £9,100.

For those over state pension age, employee NICs do not apply, but employer NICs still do.

Changing Landscape: Corporation Tax and NICs

With corporation tax rising to 25% for companies with profits over £250,000, the gap between the tax efficiency of dividends versus salary is narrowing. However, for many owner-managed companies, a low-salary, high-dividend strategy remains beneficial.

Multiple Shareholders and Dividends

In companies with multiple shareholders, each may want different amounts of profit. If there’s more than one class of shares, dividends must be paid equally, which can be problematic.

Alphabet Shares: Creating different classes of shares (known as alphabet shares) allows you to pay different dividends to different shareholders based on the class of shares they hold. This avoids HMRC challenges as long as these shares have more rights than just income rights.

Business Expenses: The “Wholly and Exclusively” Rule

Some business owners assume that their company can pay for all personal expenses and deduct them from corporation tax. This isn’t always true.

Tax Deductible Expenses: To be deductible, an expense must be incurred “wholly and exclusively” for the business. Personal expenses paid by the company are not deductible and could result in a tax charge.

Employment Benefits

When a company provides benefits-in-kind to employees, these can be taxable or exempt.

• Taxable Benefits: These benefits are subject to income tax at the employee’s marginal rate. Common examples include company cars, accommodation, and the use of company assets.
• Pecuniary Liabilities: If the director contracts with a provider personally and the company pays, this is considered a pecuniary liability and must be reported through payroll, attracting PAYE and NICs.

Director’s Loan Account (DLA)

Personal expenses can be charged to the director’s loan account (DLA), avoiding immediate PAYE reporting. However, it’s essential to:

• Ensure Sufficient Credit: Ensure the DLA has enough credit or that the company can declare dividends to cover personal costs.
• Watch Tax Limits: Extra dividends increase taxable income, which can impact thresholds like the basic-rate band (£50,270), the high-income child benefit threshold (£60,000), or the £100,000 limit for preserving the personal allowance.

If the DLA has an outstanding balance not repaid within nine months of the corporation tax period end, the company faces a 33.75% tax charge. Loans over £10,000 also create a benefit-in-kind.

Charging Interest on DLA

If the DLA is in credit, directors can charge interest on the balance, which is deductible for corporation tax purposes. This interest is taxable income but not subject to NICs.

Tax-Free Allowances: Basic-rate taxpayers can use the savings allowance (up to £1,000), and higher-rate taxpayers can use up to £500, with possible additional savings from the £5,000 starting rate for savings.

Renting Property to the Company

Directors often own trading premises personally and rent them to their company.

Tax Deductibility: Rent paid by the company is tax-deductible, provided it’s for business purposes.

Rental Income: This income is taxable for the owner but not subject to NICs. Mortgage interest on commercial properties is deductible from rental income.

However, charging full market rent can affect the availability of business asset disposal relief (BADR) on the property’s eventual sale. Using a limited company offers significant flexibility in how and when you pay yourself. You can optimise your tax position by understanding the balance between salary and dividends, handling business expenses correctly, and using tax-efficient strategies like the director’s loan account and renting property to your company. Always consult with our tax professionals to navigate the complexities and maximise the benefits for your unique situation.