In this article we explore how business owners of personal or family companies can make tax efficient profit extractions from their limited companies.
Remember, there is no strategy that suits everyone. It depends on a range of considerations, from your own personal tax position, how the company is performing, and its remaining shareholders.
Paying a minimal salary
Salary at Lower Earning Limit
One popular, tax-efficient method of profit extraction is to take a small salary and then take further amounts as dividends. Provided the salary is at least the same as the lower earnings limit (£6,396 for the tax year 23/24 and remaining the same level for the tax year 24/25), the year qualify for National Insurance contributions (NICs). This means, for instance, that it counts towards your state pension.
Salary at Personal Allowance Level
No Employee’s Primary Class 1 NICs are payable if the salary is below or equal to the primary threshold (£12,570 for the tax years 23/24 and 24/25).
If the director has their full personal allowance available for the tax year, the optimal salary will be £12,570 for the tax years 23/24 and 24/25. This means if salary is the same as the personal allowance and the primary threshold, the director will not pay any income tax on the salary either.
Watch out for the Employment Allowance
In the case where the company is a personal service company, with the director as the sole employee, then the employment allowance is not available. For the tax years 23/24 and 24/25 there will be Employers’ (secondary) Class 1 NICs to pay. The secondary threshold is £9,100, so on the £12,570 salary, the company will pay a £478.86 NICs bill.
As the corporation tax saving is greater than the NICs paid by the employer, paying the “extra” £478.86 in NICs is worth it. The corporation tax relief depends on the company’s profits but ranges from 19 to 25 per cent.
No employer’s NIC is due if the employment allowance is available. This will usually be the situation for a family company with at least two employees.
Salary above the Personal Allowance
Employees NICs at 10% in the tax year 24/25 and income tax at 20% in the tax year 24/25 are paid on a salary higher than £12,570. This means the tax paid on a salary in excess of that the £12,570 is greater than any corporation tax savings.
Remember that circumstances will differ
It will be important to check the numbers to determine the right salary for the director if they do not have the standard personal allowance and/or have used up the personal allowance elsewhere. If the director has paid in full the 35 qualifying years needed for a state pension, then paying a salary to secure a qualifying year is not required.
Taking profits as dividends
Once the maximum tax efficient salary has been established, it makes tax-efficient sense for further profits to be extracted in the form of dividends (as opposed to taking a higher salary or salaried bonus). There are few matters to bear in mind, to avoid the pitfalls:
- The company needs to have enough retained profits (these are the cumulative profits the company has made since its inception) to pay for the dividends.
- Remember that the retained profits are post tax, so you need to ensure there are sufficient funds to pay any corporation tax before paying any dividends.
- One more restriction is that dividends need to be paid in proportion to the shareholdings. For example, if shares of one class are held by more than one shareholder, there is a limit on the ability to tailor dividends. A way to manage this, is to install an alphabet share structure.
- All taxpayers, no matter what rate they pay tax at, are entitled to a dividend allowance. For the tax year 23/24 it is £1,000; for the tax year 24/25 the allowance is reduced to £500.
The dividend allowance is taxed as the top slice of income and uses up a part of the tax band in which it sits. Dividends are taxed as follows:
| Basic rate tax band | 8.75% |
| Higher rate tax band | 33.75% |
| Additional rate tax band | 39.35% |
Pension contributions
Making pension contributions with company profits can be tax-efficient, if the funds are not needed for personal use by the owners. As long as the contributions do not go higher than the director’s available annual allowance, there is no tax for the director.
The pension contributions are also tax deductible by the company, so this also lowers the corporation tax the company pays. This can be especially important, when trying to get the profits below £50,000, because the marginal Corporation tax rate increases 26.5% for profits between £50,001 to £250,000, whereas profits up to £50,000 are only charged at 19%.
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Disclaimer: This resource is provided as a guide only and we recommend seeking professional accounting advice before making decisions. Use of this guide is for reference only. Specialist Accounting Solutions Ltd accepts no liability for any errors therein or any losses or damages arising from it.
