Taking money out of your limited company should done in a tax efficient manner.
Having your own limited company is beneficial in many ways.
Not only is it a great option financially – allowing you to potentially to earn much more money and plan it tax efficiently – but it also gives you an increased sense of autonomy, and the freedom to work on your own terms.
Few people look back at their lives before being self-employed, and miss the office politics, the inflexible hours, and the lower wages.
Despite all of the benefits that come with having your own limited company, however, it can be difficult to navigate the world of tax.
If you get this wrong, then you could end up paying out a lot more than you need to, which can be pretty debilitating financially.
Avoid umbrella companies
Choosing to avoid umbrella companies – which can be more expensive – is also a good idea if you want to pay less tax in the long-run, but it means that you have a lot more to manage.
It has been proven, in fact, that you could be up to £10,000 better off if you manage your own business, instead of trading via umbrella companies and you avoid the real risk of HMRC adverse enquiries and penalties.
Support of a chartered accountant
Whilst this can seem like a much easier option, it really is worth going your own way with the support of a chartered accountant.
You need to ensure that you follow the IR35 rules, however, which we’ll look into a little bit later (and your accountant will advise you here, too).
We’ve noted down some of the best ways to draw down money from your limited company, without paying out too much when it comes to tax.
If you want to save yourself some cash, become more tax-efficient, and also make sure that you’re following the relevant tax laws, then keep these things in mind.
If you’re uncertain about anything, be sure to get in touch with our chartered accountant, who can give you advice tailored to your situation.
How does it work?
When you work for somebody else, you get your basic salary, which is usually paid monthly (or weekly in some circumstances).
There are a few different things that are deducted from your pay check, such as tax/PAYE, national insurance and pension contributions.
You don’t have much involvement with your tax or national insurance, apart from on the odd occasion, when you receive something like a tax rebate.
You can also be asked to pay more tax, if you’ve been put on the wrong tax/PAYE code.
As a limited company owner, things change quite significantly here.
Put simply, your limited company has to pay corporation tax on any profits (sales less costs) that it gets, and you have to pay personal tax on anything that you draw out of the business accounts subject to certain tax allowances.
This means that limited company owners have to pay corporation tax of 19% on all of their profits, plus any personal tax due on withdrawals.
After you allow for deductions for expenses, the company’s retained profit may be distributed to its owners via dividends.
Unlike ‘employees’, no National Insurance Contributions (NICs) are payable on dividends and more importantly the owners can set the date for tax purposes of their withdrawals to make sure they are paying a smaller consistent level of tax between the tax years rather than a high tax rate one year low tax rate the next year.
The owner/managers can also utilise the significant tax breaks/allowances relating to pension contributions also forwarded to individuals.
Having these tax benefits is vital for the survival of many small businesses, as limited company owners are not provided with the ‘employee perks’, and they also have to run their own companies, taking on the risks, hassles, and challenges that come with this.
Without this in place, there would be far fewer successful limited companies in the country.
“Leo and his team are a joy to work with. He understands fully the day to day difficulties of setting up and running a business.
His input is greatly valued and he always takes time to discuss options.
His accountancy and tax skills are highly valued. Leo and his team go that extra mile providing sound general help and advice.”
Alan WebbManaging Director, Golf Passport Ltd
What salary level should I set?
Unless you have a contract of employment with your own company stating otherwise, you have no legal obligation to give yourself a salary at all if you don’t wish to do so.
However, as your salary is deductible against the corporation tax liability of your company, it is wise to give yourself a basic income from your limited company without the contract of employment.
Thankfully, it is easy to set your salary level.
Your accountant should walk you through this, and you’ll be able to get this done quickly and efficiently, so that you’re not paying out more tax than you need to be.
As your accountant will tell you, you can’t pay somebody a salary if they’re not actually doing any work for you.
How do you pay yourself a salary?
Unless you decide to take on your company’s accounting duties yourself, you will have to hire a chartered accountant to take care of your tax and reporting obligations.
Some people would rather do this themselves, but it is a good idea to go through a chartered accountant, as they have the specialist knowledge and skills required.
It also takes a lot of time to keep on top of your accounts, and the tax laws which are constantly changing, and it’s vital to meet your tax and legal reporting deadlines.
One of the first tasks an accountant will do when you start out as a business, is to set up the company’s payroll.
You and any employees of your limited company – will receive payslips, just as you did when you were employed.
Then, you just have to transfer the net salary from the company’s business bank account into your and the employees personal bank accounts.
What about dividends?
As a limited company owner, you will draw down most of your company’s retained profits as dividends.
And, interestingly, your own company’s dividends are treated in exactly the same way as any other UK company.
The most important rule you must abide by before declaring company dividends is to ensure that the company has sufficient retained profit to cover them.
Your accountant should be the first port of call if you have any doubts about an amount of dividend that you wish to declare.
Dividends must be paid to the owners according to each individual’s shareholding in the company.
This is usually 100% for a sole shareholder, or 50% each for any joint shareholders.
Some owners make the mistake of treating their company’s finances as their own, including splitting dividends with their partners without making the necessary changes to the share structure first.
This is big mistake, and any chartered accountant will warn you against this.
Stick to the legal route if you want to be sure that you don’t face any additional tax bills and penalties in the future.
What about the paperwork?
Whilst dividends are greatly beneficial to a limited company owner, they do involve some paperwork, and it’s critical that you prepare this properly.
One of the main things to remember is that once you have decided upon a figure to distribute amongst the company’s owners, you must record the decision via board meeting minutes.
You must then issue each shareholder with a dividend voucher, which shows the net dividend amount paid to them.
The voucher itself can be physically sent to each shareholder, or you can simply attach it to an email.
It’s a good idea to do this sooner rather than later, as not doing so can lead to some confusion (and you may be breaking the law otherwise).
Some accountants will provide the dividend templates for you.
How are limited company dividends taxed?
When you first start out as a limited company, you may be confused by the concept of dividends.
But it’s actually not as complex as it seems; put simply, you are taxed on the dividend you declare/pay.
So, when you work out the dividend taxes you are liable for, you should just use the amount declared/paid
You pay your dividend tax liabilities via HMRC’s self-assessment system.
This means that you have to fill in a personal tax return each year, which is usually submitted by 31st January takes.
If you want to submit your tax return online, rather than using a chartered accountant, then make sure that you apply to use HMRC’s online services with plenty of time to spare, as without an activation code, you won’t be able to do so.
What is IR35?
To operate within the law, one thing to ensure if you are a limited company contractor is that your contracts do not fall foul of the IR35 legislation.
This can be a complex and stressful thing to navigate, but it is one thing that you really need to get right at the beginning.
In short, HMRC want to check that you’re a genuine business, rather than somebody who has a limited company only for tax reasons.
It was created to clamp down on these ‘disguised employees’, who have set up limited companies, despite the fact that their working practices are still more akin to employees, rather than the self-employed.
Remain safe from IR35
In order to remain safe from IR35, your physical signed contract with your clients must state many things correctly least of all that you are working as a self-employed individual, and the way that you actually perform your contracts must also demonstrate that you are not an employee in ‘disguise’.
An entire IR35 service industry has evolved since the rules became law, including employment status experts, firms who can check over your contract to ensure that they comply with IR35, and insurance providers.
Above all, be sure to get all of your contracts reviewed by an IR35 expert. If you don’t meet the requirements, it could cause a large tax bills and penalties in the future.
Any other advice?
To make the most out of your hard-earned income as a limited company owner, you have a fair amount of tax planning opportunities.
These generally concern how you time your dividend declarations, and also how you structure your company shareholdings.
You will be advised on this by your accountant, and it is undoubtedly true that a good chartered accountant will become your most trusted advisor over time.
The three most important things to remember – as any accountant will tell you – are:
- a) to make sure that you have enough profits in your company accounts to cover any dividends that you declare.
- b) to put aside a proportion of your dividend income each time, to allow for your income tax liability, which arises on 31st January each year.
- c) to keep accurate records, such as dividend vouchers and board meeting minutes. You never know when you might need to produce them.
Find out more
If you would like to discuss tax planning, don’t hesitate to give us a call.
We specialise in tax for companies, and we can assist you on your journey to having your own limited company, and following all of the necessary regulations to make the process go as smoothly as possible.