Journal :: Extracting Money from a Company Tax-Efficiently

Published: April 22, 2009
Author: Graham Dragon
Category: Tax
Permalink: Extracting Money from a Company Tax-Efficiently

What is the most tax-efficient way for a company director to extract money from the company?

The answer to this perennial question is, of course, dependent on individual circumstances.

For example, if the director has lent money to the company, the most tax efficient way of extracting money (at least in the short term) is simply for the company to repay the loan. Obvious, you might say! Yes, it seems blindingly obvious, yet clients do sometimes miss this strategy. How many of your clients have a directors’ loan account in the company, yet pay themselves a salary and even perhaps regular bonuses yet leave the loan outstanding? Has the accountant asked why they are doing this? Have you?

When we have addressed this question to new clients, as part of our initial top to tail review, they have sometimes answered that the company cannot afford to repay the loan. They are completely missing the point. The company is already making regular payments to the director but is choosing to classify those payments as salary, which is taxable, rather than as loan repayments, which are tax free. To put it another way, the director is choosing to pay tax on the withdrawals from the company when it would be perfectly legitimate to take those withdrawals without paying any tax at all.

If there is not a balance in the directors' loan account the choice would seem to be one of the following:

• Dividend
• Salary or Bonus
• Expenses (e.g. rent for use of an office at home)

It used to be the case that the most tax-efficient choice depended on the corporation tax rate of the company. Directors of small companies were usually advised by their accountants to take most of their remuneration as dividends, but those accountants often did not get around to advising them to change their strategy when the company became a “marginal rate??? taxpayer and it was actually more tax-efficient to receive salary or bonus than a dividend.

Corporation tax rates have moved in recent years, with large companies paying a lower rate and smaller companies paying a higher rate. Has this impacted at all on the tax-efficiency of each of the extraction strategies?

Yes, it has. It is now always more tax-efficient to take dividends than a salary, and always more tax-efficient to take expenses than a dividend. This is regardless of whether the company pays the main rate, the marginal rate, or the small rate of corporation tax. Regardless of whether the director is a basic rate or higher rate taxpayer. Unless there are radical unannounced changes in this year’s budget to the already agreed rates and thresholds, this rule will continue to apply in the current tax year.

This does not mean, of course, that your client will always be best advised, or even able, to take expenses or dividends rather than a salary. If there are no legitimate expenses to be taken, you cannot advise your client to take expenses. If the company has not made a profit and is not carrying forward undistributed reserves from earlier profitable years, you cannot suggest your client take a dividend. And you will still, presumably, wish your client to take advantage of National Insurance credits towards the state pension. But it is important to understand the tax-efficiency, or otherwise, of the strategies available to your clients.

The half life of knowledge in our industry is very short. We ignore this at our peril. If you are still of the opinion that, purely for tax purposes, your larger corporate clients should pay bonuses rather than dividends you are dangerously out of date. And if you have missed the trick of looking for ways your clients could pay themselves expenses and reduce their tax burden, then look again.

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About Graham Dragon

Note: We do not accept liability for the content of our e-mail Journal or for the consequences of any actions taken or not taken by yourself or any third party on the basis of the information provided. We are unable to advise you on tax matters. If you wish to obtain further information or help on this or on any other tax matters you should consult with a tax accountant or other suitably qualified and experienced tax professional.

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