“What’s the most tax-efficient way to extract cash from my company?” is one of the most common questions asked by owner-managed businesses.
It’s a fair question and one that, until a few years ago, had a straightforward answer: “Take a salary up to your personal allowance and draw the rest as dividends.”
Today, the picture is more complex. Tax rates have shifted, rules have tightened and the once-standard formula no longer fits every scenario. The most accurate answer we now give is: “It depends.”
Why tax-efficient extraction is no longer one-size-fits-all
For owner-managed businesses, the ideal strategy for extracting funds depends on a variety of personal and commercial factors. This includes both the company’s circumstances and those of its director-shareholders. Some of the key factors influencing an owner’s strategy may include:
- Profit levels: The company’s taxable profit determines its rate of corporation tax.
- Number of director/shareholders: The more people drawing funds, the more complex the planning becomes.
- Distributable reserves: Dividends can only be paid from accumulated profits, making available reserves critical.
- Director/shareholder’s other income: If a director/shareholder has employment, pension or investment income, their marginal rate of income tax and the amount of Personal Allowance available to them is impacted significantly.
- Age: Individuals aged 66 and over are not liable for employee National Insurance Contributions.
- Employment Allowance (EA): The £10,500 EA can offset employer NICs, but not all companies are eligible.
With so many variables, it’s no surprise that profit extraction planning has become highly individualised. Even two companies with identical profits may need completely different strategies based on their directors’ personal circumstances.
Balancing need with long-term planning
It’s important to consider how much cash the director or shareholders truly need to withdraw. Extracting the full amount of available profits from the company may seem appealing but can lead to a significantly higher personal tax liability, particularly if doing so pushes the individual into higher tax bands or triggers additional charges like the dividend tax surcharge.
Instead, a more measured approach – taking only what’s required to meet personal living expenses – can often result in a more tax-efficient outcome. The remaining profits can then be retained within the company, allowing the funds to grow or be reinvested in the business. Crucially, retained profits are not subject to personal income tax until they are extracted.
There’s also the longer-term planning angle. Some owner-managers choose to accumulate surplus funds in the company with a view to extracting them more efficiently in the future e.g. on the sale, liquidation or striking off the company. In those cases, the value of the business may be realised as a capital gain, which is subject to Capital Gains Tax (CGT) rather than Income Tax. If certain conditions are met, this gain could qualify for Business Asset Disposal Relief (formerly known as Entrepreneurs’ Relief), potentially reducing the CGT rate to 10% on qualifying gains (up to the lifetime limit).
This kind of forward-thinking strategy can be particularly beneficial where the individual does not need immediate access to all the company’s cash and is planning an eventual exit from the business.
How can we help?
If you’re an owner-manager looking to extract cash, there’s no substitute for tailored advice. From salary levels to dividend timing and capital extraction, each decision should be made with a clear view of your full tax position, cash requirements and long-term goals.
If you are looking for help with reviewing your profit extraction strategy, our team are here to help. Get in touch with your usual contact, complete our contact form or call 0161 905 1616.