Transferring Money Out of a Limited Company

A limited company is a separate legal entity distinct from its shareholders and directors. Therefore, transferring money from a limited company to a personal account of the shareholders or the directors is not a simple transaction. The amount of money taken out of the company depends on the purpose of the withdrawal and the amount involved.

As the extracted profits will be subject to taxation in the hands of the individual owners as well, it is crucial to consider the tax implications of such withdrawals before deciding on the method of extraction. The following are some of the ways to extract money from a limited company to a personal account:

Salary Payments

A common method for transferring money from a limited company to a personal account is through salaries. Limited companies paying salaries to their employees may need to operate PAYE with HMRC. All limited companies must register with HMRC as the 'employer' if employees are paid £123 or more per week or £6,396 annually. If this threshold is exceeded, limited companies must register for PAYE, even if the director is the only employee.

Once registered, the company must deduct income tax, National Insurance contributions, student loan repayments, and pension contributions from the payments to employees. If the employee's salary exceeds a certain threshold, the employer must also pay Class 1 Employer NIC. The applicable rates for NI contributions are as follows:

Companies that manage payroll themselves must report employees' payments and deductions to HMRC on or before each payday. The amount owed to HMRC can be paid monthly. Additionally, employers must keep accurate records of their employees, including their start dates and benefits, and submit annual reports to HMRC.

One advantage of taking money out of a limited company as a salary is that salaries, unlike dividends, are tax-deductible for corporation tax purposes, provided the salary is given wholly and exclusively for business purposes.

Benefits and Expenses

If a director chooses not to extract money from a limited company in the form of cash, they can do so via expenses or benefits. Expenses incurred by a company for its employees are deductible for tax purposes as long as they are for business purposes.

Benefits such as travel and accommodation, meals, training fees, etc., are some of the expenses that are deductible for tax purposes. The individual can incur these expenses and later be reimbursed by the company.

The benefits must be recorded in the P11D form by the company, and the director will pay Class 1A National Insurance on these benefits through their self-assessment tax return.

A more tax-efficient profit extraction method, therefore, is to pay a low level of salary, utilising the NIC thresholds and pay the remaining amount as dividends, given their lower tax rates. The amount that should be extracted as salary depends on whether the company can claim the employment allowance against the employer’s NIC.

Dividend Payment

Given the complexities of taking money out of a limited company as salaries, many opt to do so through dividends. Dividends are the most common type of distribution made by companies to shareholders. A dividend must be declared in a directors' meeting, with minutes maintained, regardless of the number of directors in the company.

Each dividend payment must be recorded in a dividend voucher, which includes the date, company name, names of the shareholders receiving the dividend, and the amount paid.

Although a company does not need to pay tax on dividends, a disadvantage is that dividend payments are not deductible for corporation tax purposes. However, the recipient of the dividends must pay a dividend tax on any dividends received. No dividend tax is payable if the total dividends are £500 or less for tax year 2024/25. This figure increases to £12,570 if there is no other source of income. Any amount above this threshold is taxed at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.75% for additional rate taxpayers.

It's important to note that a company must not pay out more in dividends than its available profits from the current and previous financial years. Additionally, some companies might choose to pay dividends to certain shareholders while excluding others. However, these arrangements could sometimes be seen as tax avoidance by HMRC, and the settlements legislation could come into effect. If the legislation applies, the individual waiving the dividend would still be taxed on the amount of the waived dividends. To understand how the settlement legislation may affect the taxation of shareholders, let’s consider the following scenario.

Paul and Ringo are both shareholders of Bee Ltd, each holding 50 shares. In 2024, the company earned a profit of £30,000 and declared a dividend of £500 per share. Paul chose to waive his right to any dividend, while Ringo received a dividend of £25,000.

To determine whether the settlement legislation applies, we must assess if the company could have paid the same dividend rate to Paul had he not waived his right. In this case, it is clear that the company would not have been able to distribute dividends at the same rate if Paul had not waived his share. The company would need to have a profit of £50,000 for the distributions to be feasible.

As a result, the settlements legislation applies, and Paul will be taxed on 50% of the dividends received by Ringo.

Pensions

Company contributions to employee pensions are tax-deductible expenses for corporation tax if made for business purposes. This makes pension contributions an effective way to extract profit from a limited company. Additionally, these contributions are exempt from income tax and National Insurance Contributions (NIC) for employees. Upon retirement, owners or directors can withdraw up to 25% of their pension fund tax-free.

However, there are some drawbacks to using pensions as a profit-extraction method, such as the tapering of the Annual Allowance. The tax treatment of pension contributions is complex, so it’s recommended to seek professional advice before proceeding.

Director's Loan

Another equally popular method of extracting money from a limited company is through a director's loan. A director's loan occurs when directors or close family members receive money from the company that is not classified as a salary, dividend, or money previously paid into the company.

Both the company and the directors may have to pay tax on a director's loan. The obligations of the company and the loan recipients also depend on the amount of the loan.

Loans Exceeding £10,000

If you are a shareholder and a director of a company and owe the company more than £10,000 at any time during the year, the company will treat the loan as a 'benefit in kind' and deduct Class 1 National Insurance. The company must use the CT600A form to prepare its company tax return, showing the outstanding balance at the end of the accounting period.

Whether the loan remains paid or unpaid for longer than 9 months and 1 day from the end of the corporation tax period, the company will pay tax at 33.75% on the outstanding amount. When the loan is permanently repaid, the corporation tax can be reclaimed. The company must claim back the tax within 4 years from the end of the accounting period in which the loan was taken out.

Additionally, the director (and shareholder) must show the outstanding loan on their Self-Assessment Tax Return.

Loans Below £10,000

For director's loans below £10,000, shareholders or directors do not need to show the loan on their tax return. Likewise, the company doesn't need to treat the loan as a 'benefit in kind'. However, they must still fulfil their obligations and prepare the CT600A form.

If the person receiving the loan is not both a shareholder and a director, these obligations do not apply to either party. However, if the recipient is solely a director and receives a loan exceeding £10,000 at an interest rate below market value, a benefit in kind will be established. This benefit must be reported on form P11D, with the employer paying Class 1A National Insurance on the benefit. Additionally, the benefit must be included in the director's self-assessment tax return.

Reclaiming Corporation Tax on Directors' Loan

As previously mentioned, when the directors' loan is completely repaid, written off or released, the corporation tax paid at 33.75% may be reclaimed. The procedure to do so may vary depending on when the claim is made.

Reclaim Within 2 Years

If the corporation tax is reclaimed within two years from the end of the accounting period in which the loan was taken out, companies can use one of the following methods:

• Prepare their Company Tax Return for that accounting period using the CT600A form.
• Amend the previous CT600A.

If the tax return relates to a different accounting period than when the loan was taken out, companies must use the L2P form with their Company Tax Return to make the claim.

Reclaim After 2 Years

If the corporation tax is reclaimed after two or more years from the end of the accounting period in which the loan was taken out, the L2P form must be filled out. This form can either be posted separately to HMRC or attached to the Company Tax Return.

Conclusion

In conclusion, transferring money out of a limited company involves navigating various regulatory and tax implications unique to each method. Whether opting for salaries, benefits, dividends, or director's loans, it is crucial to thoroughly evaluate the specific circumstances and tax consequences of each approach.

By carefully considering these factors and ensuring compliance with all legal and tax obligations, directors and shareholders can make informed decisions that best suit their financial and business needs.