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A limited company is run by the director(s) and owned by the shareholder(s). This means that the day to day decisions are made by the directors but the profits belong to the shareholders, depending on the percentage share that they own in the company.

Directors are classed as employees of the company and so will usually take a salary. Company profits are extracted from a company in the form of dividends. Dividends are simply profits which are paid from the company to its shareholders (owners).

In many small companies the director and shareholder are the same person. If this is the case then an opportunity Limited Company Advicearises for that individual to extract money from the company more tax efficiently. This is done by taking a small salary up to the national insurance threshold (secondary threshold) as the director and the remainder of the withdrawals in the form of dividends as the shareholder. For example, a business owner may want to take £30,000 from the company during a year. For the 2013-14 tax year a directors salary would be declared of £7,696 (or approx. £641 per month) and the remainder (£22,304 in dividends, £30,000 – £7,696).

The reason this is so tax efficient is because there is no personal tax or national insurance for the director to pay as the salary is below the relevant thresholds. Despite no national insurance becoming liable to HMRC, contributions are still made on the director’s behalf towards their state pension and other benefits. Similarly, there is no personal tax to pay on the dividends as they are below the relevant threshold. The salary is also an expense to the limited company which reduces the company tax (corporation tax) due.

There are some assumptions made here that you should be aware of. This example assumes the business owner does not have any other sources of income. If for example the director had other income of £2,000 then a lesser salary could be taken (£5,696), or if the additional income was over £7,696 then it may be better just to take dividends (assuming the company has the profits or reserves available).

Any dividends taken over a certain threshold will incur an additional 25% tax so it is always worth checking the threshold before deciding on your dividend amounts.

Sometimes a spouse will work within the company to utilise their allowances. This can essentially double the tax and NI free allowances available.

 

How is director’s salary processed?

With the introduction of the new Real Time Information (RTI) scheme by HMRC at the beginning of the tax year (6th April 2013), employers must now submit an RTI return to HMRC detailing employees pay “on or before” the time of payment. This means that for employers who pay their employees weekly such as every Friday, an RTI submission will need to be made on or before this date every week. Directors are normally paid monthly as this means there is less chance of a return being late and incurring fines.

About The Author

Karl Bilby

We work very closely with our expert accountants to bring you the latest factually correct tax and accounting news. We also enjoy writing about small business news that we hope you find useful!

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