Are you optimising profit extraction from your business?
If you’re a business owner of a limited company, it’s important that you know how to make the most of your after-tax profit to support your personal financial health – known as profit extraction.
There are several ways you can do this, including:
- Salary
- Dividends
- Director’s loans
You can use all these strategies as the foundation for optimised profit extraction, allowing you to benefit from the success of your business.
A separate entity
A limited company is legally separate from you and your personal finances, which is a double-edged sword when it comes to profit extraction.
You are personally protected from liabilities relating to tax and debts taken on by your business when you operate a limited company, but profits also belong to the company rather than to you.
For this reason, profit extraction is a major factor in deciding whether to incorporate your business or operate as a sole trader or partnership.
Paying a salary
As a company director, you’re typically classed as an employee of the business and are therefore entitled to be paid a salary through the payroll.
This can be any amount that you like, as long as you’ve covered all operational and staffing costs, but you may choose to take a lower salary up to the value of your Personal Allowance – £12,570.
Used alongside other extraction methods, a lower salary can be a tax-efficient way of receiving profit from your company.
Dividends
Dividends are paid when your business makes a profit. Some of this profit is paid to shareholders (including yourself as a director).
Dividends are becoming less tax-efficient as a profit extraction method than in previous years.
The tax-free Dividend Allowance has decreased significantly in recent years, falling from £5,000 in 2017/18 to £500 in 2024/25.
However, if you pay yourself a lower salary, you may still benefit from a lower rate of tax on your dividends than if you earned a higher salary, because dividends are taxed at a rate which is tied to your Income Tax band:
- Basic rate – 8.75 per cent
- Higher rate – 33.75 per cent
- Additional rate – 39.35 per cent
For example, if you earn:
- £12,570 in salary
- £15,000 in dividends
You would have a total income £27,570, but your salary falls within your Personal Allowance, so is not subject to tax.
Take away your £500 Dividend Allowance and you pay tax on £14,500 of dividends.
You’ll be taxed in the lowest band at a rate of 8.75 per cent. In total, you’ll pay £1,268.75 in tax for the 2024/25 financial year.
In contrast, if you earned £27,570 as a salary with no dividends, you would pay Income Tax at 20 per cent on £15,000, resulting in a tax liability of £3,000.
However, it is also important to note that a higher salary means higher overall staff costs, which reduces overall taxable profits for the company.
A higher salary for yourself as a director therefore creates a reduced Corporation Tax liability – although the benefits of this will vary depending on the overall level of profits made by your company.
Corporation Tax is charged at different rates depending on how much profit your business makes, with a main rate of 25 per cent applied to profits over £250,000, 19 per cent for profits below £50,000 and on a rising scale for profits between these thresholds.
Director’s loans
Director’s loans are a way of extracting profits from your business without creating an immediate tax liability for you.
You borrow money from your company which is repaid at a later date, typically within nine months of the end of your business’ accounting period (AP).
Tax considerations may include:
- Income Tax – Not generally paid on director’s loans, although you must report a ‘written off’ (non-repayable) loan by Self-Assessment
- National Insurance – Your business must pay Class 1 NI on written off loans or on loans of £10,000 or more, which are classed as benefits in kind.
- Corporation Tax – Loans made to a director of a close company with a material interest in the business may be subject to Corporation Tax, which is refundable upon payment of the loan.
These should be used carefully to avoid disrupting your business’ cash flow or creating personal debts, which you cannot manage.
Seeking advice
We can support you in developing your profit extraction strategy to maximise the benefit to your personal finances and minimise tax liabilities.
Contact our team today to discuss your requirements and get started on enhancing your financial health.
