How can I extract profits from my limited company? Part 1.
Property investment using a limited company structure usually works best when profits are reinvested into the business and used to buy more property. This has the advantage of achieving a compounding effect as profits are continuously reinvested into the business and is an excellent way to grow wealth over time. That said, there will likely come a time in an investing career where the owners may wish to access their profits to support their lifestyle, replace a salaried income or any other number of reasons. This article will seek to address the primary ways that a business owner can extract profits for their business in a tax efficient manner.
Part 1 of this article focuses on directors loans, salary and dividends which are all ways that a property can access their profits in a tax efficient way and aims to help answer the question of how to extract profits from a limited company.
Directors Loan Account. If the company's property purchases were funded by the owners injecting their capital into the business then this will create a Directors Loan Account. Here a director invests their capital into the company to use for property purchases and refurbishments. With property investing being such a capital intensive business, the balance on the directors loan can grow to be a significant amount over time. This is treated as a loan to the company which needs to be repaid. There is also the option to charge interest.
Director’s Loan interest. The directors loan is unsecured and therefore the lender is able to charge a commercial rate of interest. No national insurance is paid on Interest and there is presently a £1,000 personal savings allowance (reduced to £500 for higher rate taxpayers). The savings allowance means you will pay no interest if you earn this in interest. There is also a £5,000 savings nil-rate band which is designed for low earners to pay no interest on this amount of interest. The company should be able to benefit from tax relief on interest it pays. These reasons can make charging interest highly tax efficient, depending on the directors personal tax position. At the very least the director should consider charging sufficient interest to enable the director to claim their personal savings allowance. If interest is charged then a company will need to submit a CT61 return to HMRC.
Repay capital on Director’s Loan Account. As with any loan at some point in time the capital on the loan will have to be repaid. The beauty of a directors loan is that the director can be paid back at any point in time, subject to there being sufficient funds within the company to do so. This means it can be paid even if the company is not yet profitable. A partial repayment of the directors loan will simply reduce the amount on the account. Take care not to become overdrawn on the account that as this can cause an unexpected tax liability.
Salary. Payment of a small salary can be a tax efficient way of extracting cash from a limited company. Payment of a small salary can ensure that a director is able to benefit from entitlement to the state pension. It is also possible that it could be tax free for the director if they are below the personal allowance. The disadvantage is that It will create an administrative burden as the company has to conduct payroll activity, declare any tax due on salaries and pay HMRC as required. The amount of salary a director wishes to pay themselves will depend on their personal tax situation. They will pay the following tax rates for tax year 20/21:
Nil up to £12,500 personal allowance
20% up to £50,000 basic rate
40% up to £100,000 higher rate
60% marginal rate between £100,000-£120,000 (phased out reduction of personal allowance)
45% if over £120,000 additional rate
National Insurance Contributions (NIC’s)
Company. 13.8% employers NIC’s if above the secondary threshold of £732/month.
Top Tip. There is an Employment Allowance (EA) which enables businesses to reclaim up to £4,000 in Employers’ NICs. Company directors who receive small salaries can only benefit if they earn £8,788 or more per year. The EA cannot be claimed if there is a sole director.
Director. 12% Employees NIC’S if your salary is above the primary threshold which is £792/month.
2% on earnings that are above the upper earnings limit of £4,167/month.
Top Tip. From a purely NIC’s perspective, the optimum directors salary for 20/21 is £8,788 per year. This will mean there will be no NIC’s paid by the company or the director, but the director will still have access to the benefits of NIC’s such the state pension. Yes even without paying a penny of NIC’s.
Top Tip. The above guidance is based purely on optimum structures for minimising the payment of tax. Assuming this is your only source of income then you also need to speak with a mortgage broker to see what minimum salary from property income would be acceptable in order to be able to have access to finance. Similarly you may want to consider access to finance for your residential mortgage and so ask them about that too.
Dividends. Dividends can be an efficient way of extracting profits from a company. Dividends can only be declared on post tax profits and therefore may not be available to the company directors during the early years of investing through a company. Dividends are not subject to NIC’s.
20/21 Dividend Tax Rates
Tax free up to £2,000 per year
7.5% up to £50,000 basic rate
32.5% up to £150,000 higher rate
38.1% above £150,000 additional rate
Top Tip. If your company declares a dividend it does not need to be paid out to the directors as cash. Instead the directors can choose to add this amount to the directors loan account, meaning it can be extracted at a later date. This could mean the director is able to earn additional interest (assuming interest is charged on the directors loan). This allows the amount to be reinvested into buying more property, further compounding your wealth.
The first part of this article has attempted to highlight some of the ways that a property investor can extract profits from their limited company. Part 2 of this article will explore taxable and tax free benefits, which offer another way for property investors to access profits in a tax efficient manner. It will also look at the optimal combinations of these different methods of extracting profits to ensure that the investor pays the minimal amount of tax.
If you need help with working how you can access profits from your company then we offer a number of different packages for the owner of a limited company. If you would like to discuss this with us then please get in touch with us.
Click here for more blog posts on property tax and investing.