HMRC Investigations: What Triggers a Business vs Personal Tax Check and How to Prepare

Many directors wonder how best to take money out of their business. The main options are salary, dividends, or loans. Choosing the right method depends on the company’s profits, tax rules, and the director’s personal financial situation.

Paying a salary means the company must register as an employer and deduct Income Tax and National Insurance. Dividends can only be paid if the company makes a profit after tax and usually have different tax advantages. Taking a director’s loan may work in some cases but can lead to complications if not managed carefully.

Understanding these differences is essential for making informed decisions that comply with legal requirements and optimise financial benefits. This article will explain each method clearly to help directors decide the best way to withdraw money from their company.

Understanding How To Draw Money from a Limited Company

When taking money from a limited company, directors must choose between salary, dividends, or loans. Each method affects cash flow, tax obligations, and accounting records differently. Choosing the right way depends on the company’s profits, legal rules, and personal tax situations.

Overview of Salary, Dividends, and Loans

A director’s salary is paid through the company payroll, requiring registration as an employer. Income Tax and National Insurance contributions are deducted at source, ensuring the director pays tax like an employee. Salaries offer a regular income and count as a business expense, reducing company profits.

Dividends are payments made to shareholders from company profits after tax. They do not require National Insurance payments but must only be issued if the company has enough retained earnings. Dividends provide tax-efficient cash but depend on the company making a profit within the accounting period.

A director’s loan allows borrowing from the company or lending money to it. The loan must be recorded in the director’s loan account. If not repaid in time, it can trigger tax charges. Loans offer flexibility but can affect the company’s cash flow and must be handled carefully.

Key Considerations Before Withdrawing Funds

Directors should check their company’s cash flow before drawing money, ensuring the business can afford withdrawals without harming operations. Taking money too early or without profit can cause financial trouble.

The company’s accounting period affects dividend payments. Dividends can only be issued out of profits made in that period or earlier retained profits. Failing to follow this risks penalties and legal issues.

Tax rules differ for salary, dividends, and loans, so directors need to plan withdrawals according to personal tax bands and company profits. Proper records must be kept to avoid problems with HMRC or other regulators.

Registering the company as an employer is mandatory when paying salaries, and all deductions must be reported correctly. This legal requirement adds administrative work but ensures compliance.

Directors must balance drawing cash with maintaining company stability and adhering to tax laws to manage funds properly. For further details, see how to take money out of a limited company.

Paying Yourself a Salary from Your Company

A company director can pay themselves a salary in a structured way that follows legal regulations and tax rules. It is important to keep salary payments above certain limits, consider tax and National Insurance costs, and use personal allowances wisely to reduce the overall tax burden.

Salary Structure and National Minimum Wage

The salary paid to a director must respect the National Minimum Wage (NMW) if they are classed as a worker. Directors often have flexible pay structures, but if they also do other work for the company, their salary should at least meet the NMW for the hours worked.

Many directors choose to pay themselves a low salary just above the Primary Threshold for National Insurance Contributions (NICs), which was £12,570 per year for the tax year 2024/25. This allows them to gain state benefits without paying employee or employer NICs. The salary can be paid monthly or annually, but payments must be declared through PAYE.

Paying Bonuses

Bonuses are additional payments to a director and are treated like regular salary for tax purposes. They are subject to both income tax and National Insurance Contributions.

Directors and companies should agree bonuses formally, documenting them clearly in board minutes or resolutions. Paying bonuses can be a way to reward performance or reflect company profits, but the total salary plus bonuses should not put the company at risk of financial issues. Bonuses increase tax liabilities and must be reported in the company’s payroll.

Tax on Salaries and National Insurance

Salaries are subject to income tax at standard rates and National Insurance Contributions. Employer NICs are payable by the company on salaries above £12,570 per year at 13.8%. Employees pay NICs at 12% on earnings between £12,570 and £50,270, and 2% above that.

Income tax rates start at 20% on earnings over the personal allowance. Salary payments go through Pay As You Earn (PAYE), and the company must submit Real Time Information (RTI) reports to HMRC. The director must include salary income in their self-assessment tax return.

Personal Allowance and Tax Planning

The personal allowance is the amount a person can earn tax-free each year, set at £12,570 for 2024/25. Directors often set their salary close to this figure to avoid income tax but still gain qualifying years for state benefits.

Tax planning aims to balance the salary with dividends, which are taxed differently to reduce overall costs. Paying a salary just above the National Insurance primary threshold achieves this.

Directors must report income through self-assessment to ensure correct tax is paid. Employers should keep good records and plan payments in advance to stay within tax rules and avoid penalties from HMRC.

Taking Out Dividends as a Shareholder

Taking dividends is a common way for shareholders to withdraw money from a limited company. It requires following specific rules about when and how much can be taken to avoid legal issues. Shareholders must understand taxes on dividends, available allowances, and how dividends relate to corporation tax.

Dividend Distribution Rules

Dividends can only be paid out of company profits after corporation tax has been paid. If the company does not have sufficient profits, declaring dividends is illegal and can lead to penalties. Directors must ensure the company’s accounts show enough retained earnings before approving dividends.

Dividends are usually paid to shareholders in proportion to their shareholding. Notice of a dividend payment should be documented, often through a dividend voucher. Companies must not confuse dividends with salary payments, as these have different tax and legal rules.

Dividend Tax Bands and Rates

UK dividend tax rates depend on the shareholder’s income tax band. For the tax year 2025-26, the rates are:

Dividends below the personal allowance are tax-free, but once income exceeds this, dividends are taxed at the relevant rate. The higher the shareholder’s total income, the higher the dividend tax rate they pay. Proper tax planning can help manage these costs.

Tax-Free Dividends and Allowances

Every individual has a tax-free dividend allowance, which is £1,000 for the 2025-26 tax year. Dividends received within this allowance are not subject to dividend tax.

If an individual’s total dividend income stays under this allowance, no tax is due. Dividends above this limit are taxed according to the relevant tax band. This allowance is separate from the personal allowance for earned income, so dividends can be a tax-efficient way to take money if planned properly.

Corporation Tax Interaction with Dividends

Dividends are paid after the company has paid corporation tax on its profits. This means dividends can only be declared from post-tax profits. The current corporation tax rate affects how much profit is left for dividends.

If a company pays out more in dividends than its available profits, it risks legal consequences. Good record-keeping and understanding of corporation tax liabilities are essential to avoid paying ‘illegal dividends.’ Directors should monitor both corporation tax and dividend payments to balance tax efficiency with compliance.

For more details on taking money out of a limited company and tax rules, shareholders can consult official government guidelines.

Using Director’s Loans to Withdraw Money

A director’s loan lets a director take money from their company beyond salary, dividends, or expenses. It comes with specific rules about how much can be withdrawn, tax duties, and the effects if not repaid on time. Understanding these points helps avoid unexpected costs or penalties.

How Director’s Loans Work

A director’s loan happens when money is taken from the company but is not salary or dividends. This loan is recorded in the company’s books and must be repaid. The company’s accounting period tracks how long the loan exists.

If the loan is not repaid within nine months after the accounting period ends, the company must pay extra Corporation Tax. The loan balance is shown as an asset in the company’s accounts until cleared.

Directors can lend money back to the company, reducing what they owe. Loans should always be carefully tracked to avoid misunderstandings or tax issues. For detailed rules, see the director’s loans overview on GOV.UK.

Tax and Reporting Obligations

Any director’s loan over £10,000 creates tax issues. The loan must be declared on the director’s self-assessment tax return. If the loan is still unpaid after nine months from the company’s year end, the company pays a 32.5% tax charge on the outstanding loan amount. This charge can be reclaimed once the loan is repaid.

The loan needs to be recorded properly in the company’s accounts and annual tax return to HMRC. Failure to do so can lead to penalties or delayed repayments of tax charges.

The money taken as a loan is not treated like salary or dividends. This means no automatic income tax or National Insurance is due when the loan is taken out, but tax rules still apply on late or unpaid loans.

Benefit in Kind Implications

If the director’s loan amount exceeds £10,000 during the year, the company must report this as a benefit in kind. This means the director may have to pay income tax on the value of the loan’s interest benefit.

If the company does not charge interest or charges below the official rate set by HMRC, the difference is taxed as a benefit in kind. The company must report this on form P11D each year.

The director also has to include this benefit on their self-assessment tax return. Charging interest at or above HMRC’s official rate avoids the benefit in kind tax but requires careful record-keeping.

For more information, visit the rules about taking money out of a limited company.

Comparing Withdrawal Methods: Which Is Best For You?

Choosing how to take money from a limited company depends on tax costs, cash availability, and legal rules. Salary, dividends, or loans each have different effects on income tax, company cash flow, and paperwork.

Weighing Up Tax Efficiency

Salary is subject to income tax and National Insurance contributions (NICs). For directors, paying a salary up to the personal allowance helps reduce tax but incurs employer NICs. Higher salaries increase tax and NICs for both employee and employer.

Dividends are paid from company profits after corporation tax and attract lower personal tax rates than salary. Basic rate taxpayers pay less tax on dividends, but higher rate taxpayers face increased tax at 33.75%. Dividends don’t affect NICs, making them more tax-efficient if the company has enough retained earnings.

Loans from the company must be repaid within nine months of the tax year-end to avoid tax charges. If unpaid, the company pays a tax charge, and the director may face income tax. Loans are not taxed as income initially but can trigger tax if not properly managed.

Cash Flow and Practical Considerations

Salary payments are regular and predictable, which helps with personal budgeting. The company needs enough funds to cover salaries and NICs payments on time.

Dividends rely on available profits after expenses and taxes. If profits are low or retained earnings are insufficient, dividends may not be a reliable method for taking income regularly.

Loans allow directors to take money without immediate tax, but the company must have good cash flow to cover repayments. Loans may disrupt company finances if not managed carefully.

Compliance and Record-Keeping

Salary requires payroll setup and submission of PAYE returns to HMRC. Accurate records of salaries, NICs, and income tax deductions are essential and must be kept for several years.

Dividends need proper documentation in board minutes and dividend vouchers. Payments must match the company’s profits and comply with company law.

Loans demand precise records of amounts lent and repayments. If loans are written off or not repaid, tax authorities may investigate, and penalties could apply.

For more details on tax efficient ways to take money from your company, see this article on salary vs dividends tax efficiency for directors.