If you run a family or personal company, you will need to consider how best to extract profits for your personal use. There are various ways in which you can do this. A traditional tax-efficient approach is to take a small salary and to extract any further profits as dividends. However, you can also extract profits in other ways.

Salary

If you pay a salary that is at least equal to the lower earnings limit for National Insurance purposes (set at £6,240 for 2021/22), the year will count as a qualifying year for state pension and contributory benefit purposes.

To be eligible for the full single tier state pension when you reach state pension age, you will need 35 qualifying years of contributions.

The optimal salary for 2021/22, will depend on whether or not your company is entitled to the National Insurance employment allowance. If you run a personal company, you will not qualify for the employment allowance as it is not available where the sole employee is also a director.

As long as your personal allowance has not been used elsewhere, if the employment allowance is not available, your optimal salary for 2021/22 is one equal to the primary threshold of £9,568.

Where the employment allowance is available, for example, if your company is a family company with more than one employee, your optimal salary level is one equal to the personal allowance, set at £12,570 for 2021/22. You can pay a salary to other family members who work for the company too, but you will need to ensure they are paid a commercial rate for the work they undertake.

Dividends

Once you have paid yourself the optimal salary, it is tax-efficient to extract further profits in the form of dividends rather than paying yourself a higher salary. However, you can only pay dividends out of retained profits and, therefore, you must have sufficient retained profits to cover the dividends that you wish to pay.

Dividends must be paid in proportion to shareholdings. However, if you use an alphabet share structure, whereby each shareholder has their own class of share (e.g., “A” ordinary shares, “B” ordinary shares, etc.) you can tailor dividend payments by declaring different dividends for different classes of shares.

All taxpayers, regardless of the rate at which they pay tax, have a dividend allowance. This is set at £2,000 for 2021/22. Dividends covered by the allowance are tax-free. If shareholders have their dividend allowance available, paying a dividend to use up the allowance enables profits to be extracted from the company without paying further tax.

Once the dividend allowance has been used up, dividends (which are taxed as the top slice of income) are taxed at:

• 7.5% where they fall within the basic rate band,
• at 32.5% where they fall within the higher rate band and
• at 38.1% where they fall within the additional rate band.

As dividends are paid out of retained profits it should be noted that they have already suffered corporation tax at 19%.

Rent

If you run your company from home, you can consider renting your home office to the company. The rent, which should be at a commercial rate, is deductible in computing the company’s taxable profits. However, you must pay income tax on rents received in this way and declare them on your self-assessment tax return. On the plus side, there is no National Insurance to pay.

Benefits in kind

There are a number of tax exemptions for benefits in kind, such as those for mobile phones and trivial benefits, which enable you to extract profits without an associated tax or National Insurance liability.

Pension contributions

You can also extract profits in the form of pension contributions as your company can pay contributions into a pension plan for you (as long as your available annual allowance has not been used up).

Director’s loan

If your need money for a short time, taking a director’s loan can be tax efficient. You can borrow up to £10,000 for up to 21 months tax-free. However, there are tax consequences if the balance exceeds £10,000 at any point in the tax year or if you do not repay the loan within nine months and one day of the end of your accounting period.

Interest on loans to your company

If you lend money to your company there is no reason why you should not charge interest. Interest would not be subject to National Insurance deductions and may be covered by an annual savings allowance. In which case no income tax charge would arise.

Leave profits in the company

Extracting profits from your company may trigger a further tax and National Insurance charge. If you do not need the profits for personal use, consider leaving them in the company to extract later when this can be done more tax efficiently.

We can help

As everyone’s personal tax affairs are unique, planning for the best combination of extraction strategies can be challenging.

Please call so we can consider your options.