Salary, dividends and director’s loans: taking money out correctly

Salary is an employment payment

A director can receive salary for work done. The company must consider payroll registration, reporting, deductions and employer responsibilities under the applicable rules. A one-person company is not automatically exempt from these arrangements.

Ask your accountant to model salary alongside other income, benefits and pension plans. A universal “optimal salary” figure may not fit your position or the company’s employer obligations. Keep payroll records and make the payments match the records.

Dividends require available profits and records

A company can pay dividends only from profits available for distribution, following the rights attached to the shares. Having cash is not the same as having distributable profit: the balance may include loans, taxes owed or money committed to other liabilities.

Check reliable accounts before declaring a dividend. Follow the company’s decision-making procedure, keep the required minutes and issue a dividend voucher recording the date, company, shareholder and amount. Even a sole director must keep appropriate records.

A director’s loan is not a catch-all tax-free withdrawal

Money you take that is not salary, a dividend, an eligible expense reimbursement or repayment of money you previously lent can create a director’s loan balance. Money you lend to the company can produce a balance in the other direction.

Loans can have company tax, personal tax and benefit implications depending on amount, interest, dates and repayment. Keep a separate loan account and get advice before using it to fund personal spending. Repaying briefly and withdrawing again may not produce the result you expect.

Reimburse genuine business spending carefully

If you personally pay a company expense, keep the receipt and record why it belongs to the company. Reimbursement and tax treatment depend on the nature of the cost. Personal or mixed-use spending cannot simply be relabelled as a business expense.

Company payment of a personal expense may instead need treatment as remuneration, a benefit or a loan. An accountant can advise on travel, homeworking, equipment and other borderline categories. Retain evidence rather than relying on a bank-statement description alone.

Put a withdrawal process in place

Agree how frequently payroll runs, when dividend checks are made and how personal payments are recorded. Reconcile the director’s loan account regularly and reserve cash for tax. Tell your accountant about all withdrawals rather than waiting for annual accounts.

Your personal tax position can change with other income, tax-year rates and allowances. This article does not prescribe a salary/dividend mix. Use current HMRC guidance and individual advice before committing to a payment plan.

Worth knowing: Recording a withdrawal accurately at the time is safer than trying to decide a year later that every payment was a dividend.

Before paying a dividend, test profits rather than bank cash

Illustrative example: the bank has £20,000, but £12,000 is a director loan and £3,000 represents unpaid supplier liabilities. The balance does not establish £20,000 of distributable profits. Review accounts, accumulated profits and losses, tax provision and the company’s legal distribution position before declaring a dividend.

Suppose reliable accounts establish £8,000 of profits available for distribution and the directors decide to distribute £4,000. Record the decision and issue dividend vouchers. If two holders have equal ordinary shares with equal rights, do not simply pay only the founder who wants cash without considering the share rights and advice on any proposed waiver or different arrangement.

A dividend is not a Corporation Tax deduction and the shareholder’s personal tax is separate. There is no universal salary-and-dividend combination that is best for every director. Other income, employment status, pension plans, company profits and the tax year can change the result.

Use a director loan account as a ledger, not a substitute for a withdrawal plan

When you lend money to the company, record the amount, date and terms. A repayment of that genuine loan is different from salary or a dividend. When you take company money that is neither valid pay, a lawful distribution nor reimbursed business expenditure, record the advance and assess the director-loan rules.

An overdrawn director loan can trigger a company tax charge and, depending on the amount and terms, a taxable benefit. Repayment timing and rules on replacing one loan with another matter. Do not assume moving money back shortly before a deadline automatically removes every tax consequence.

Reconcile the loan account monthly and review it before the year end and before each significant withdrawal. Preserve invoices for expenses paid personally on the company’s behalf. If a past transfer was mislabelled, obtain advice rather than manufacturing retrospective dividend paperwork to make the bank statement look tidy.

Choosing Your Mix: Salary vs. Dividends in Practice

For a director who is also a shareholder, the most common remuneration strategy is taking a small salary and extracting further profits as dividends. The optimal salary level is typically set by National Insurance thresholds. Taking a salary up to the Lower Earnings Limit ensures you qualify for state benefits like the State Pension without any tax or National Insurance Contributions (NICs) being paid. A slightly higher salary, up to the Employer's NIC threshold (£5,000 per year), can also be efficient as it avoids the 15% charge for the company. For companies eligible for the Employment Allowance of £10,500, it may be efficient to pay a salary up to this level, as the allowance can be used to offset the resulting employer's NICs liability. This strategy is effective because salary above these thresholds attracts both employee and employer NICs, plus income tax.

Once the optimal low salary is paid, dividends become the preferred method for further withdrawals. Dividends are paid out of post-Corporation Tax profits and do not attract any National Insurance. While dividends are subject to income tax, the rates are lower than for salary, and the first £500 is tax-free thanks to the Dividend Allowance. This combined 'low salary, high dividend' approach significantly reduces the overall tax burden compared to taking all remuneration as salary. The decision requires careful calculation based on the company's profitability, its eligibility for the Employment Allowance, and the director's personal tax position. It is not a one-size-fits-all solution and should be reviewed annually as tax rates and thresholds change.

The introduction of marginal relief for Corporation Tax (CT) adds another layer to this calculation. Companies with profits between £50,000 and £250,000 pay CT at a rate that gradually increases from 19% to 25%. A larger salary payment reduces the company's profit, potentially lowering its CT rate, but this tax saving for the company comes at the cost of higher personal tax and NICs for the director. For most small, profitable businesses, the NIC savings from a dividend-based strategy will almost always outweigh the potential CT saving from a higher salary. Directors must therefore model the total tax impact, considering CT, employer NICs, employee NICs, and personal income tax on both salary and dividends to find their optimal extraction point.

Worth knowing: For a typical profitable small company, a low salary complemented by dividends results in significantly higher net cash for the director, as illustrated by the scenarios assuming the company can claim the Employment Allowance.

Declaring a Legal Dividend: A Step-by-Step Guide

Correctly documenting the dividend process is a non-negotiable legal requirement under the Companies Act 2006. It is not enough to simply have sufficient profits in the company; a clear, contemporaneous paper trail must be created to prove the distribution was properly authorised. This process protects the directors from accusations of acting improperly and ensures the payment is not re-characterised by HMRC as a salary, which would attract significant tax and National Insurance liabilities. The core of this procedure involves a formal decision by the board of directors. This decision cannot be a casual conversation; it must be formally recorded. Any failure in this administrative process can render an otherwise legitimate dividend 'ultra vires' (beyond the powers of the directors), creating a personal liability for them to restore the funds to the company.

The key documents are the board meeting minutes and the dividend vouchers. The minutes serve as the primary legal evidence that the directors met, reviewed the company's financial position to confirm the existence of sufficient 'distributable profits', and formally resolved to pay a dividend of a specific amount on a specific date. Distributable profits are defined as a company's accumulated realised profits less its accumulated realised losses. This figure is found on the company's balance sheet, not its bank statement. Following the board resolution, a dividend voucher must be issued to each shareholder receiving a payment. This document acts as a receipt for the shareholder and contains the key details of the payment for their personal tax records. These documents should be retained securely for at least six years.

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   Step 1: The directors must first prepare interim accounts or review the latest statutory accounts to determine the exact amount of distributable profits available.

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   Step 2: Convene and hold a board of directors' meeting. Even in a single-director company, a formal minute of the decision should be created.

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   Step 3: At the meeting, formally resolve to declare a dividend, recording in the minutes the total amount to be paid, the amount per share, the shareholders who will be paid, and the payment date.

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   Step 4: Create a distinct dividend voucher for each shareholder. This must show the company's name, the date, the shareholder's name and address, the number and class of shares they own, the dividend rate per share, and the total tax credit and dividend payable.

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   Step 5: Execute the payment from the company bank account to the shareholders' personal accounts on the specified date.

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   Step 6: File copies of the board minutes and dividend vouchers in the company's statutory records. Provide the vouchers to the shareholders for their Self Assessment tax returns.

Worth knowing: Formally minuting the board's decision and issuing dividend vouchers are essential legal steps to prevent a dividend being declared illegal or reclassified as salary by HMRC.

The Risks and Remedies of Illegal Dividends

An 'illegal' or 'ultra vires' dividend is any distribution to shareholders that is not made in accordance with the Companies Act 2006. This commonly occurs in two ways: firstly, when a dividend is paid when the company has insufficient distributable profits, and secondly, when the correct administrative procedure (board minutes, vouchers) is not followed, even if profits were available. In both cases, the legal consequence is the same: the dividend is void. The amount paid automatically becomes a debt owed back to the company by the shareholder who received it. If the shareholder knew, or had reasonable grounds to believe, that the dividend was unlawful, they are liable to repay it.

Crucially, liability does not stop with the shareholder. Directors who approve an illegal dividend are in breach of their duties and can be held personally liable to reimburse the company for the full amount, especially if the shareholder is unable to repay the funds. This risk becomes acute if the company later becomes insolvent, as a liquidator will be legally obliged to pursue the directors to restore the company's assets for the benefit of its creditors. This is not a theoretical risk; liquidators routinely challenge improperly documented or excessive dividends paid in the lead-up to insolvency. Ignoring the correct procedure is a false economy that exposes directors to significant personal financial danger.

Worth knowing: An illegal dividend creates an immediate debt to the company and exposes directors to personal liability, a risk that requires prompt correction through repayment or a subsequent legal declaration.

Company Pension Contributions: A Tax-Efficient Alternative

Beyond salary and dividends, making an employer pension contribution is a highly tax-efficient method for a director to extract value from their company for long-term benefit. When the company makes a contribution directly into a director's personal pension scheme, the payment is normally treated as an allowable business expense. This means the full amount can be deducted from the company's profits before calculating its Corporation Tax bill, providing relief at either 19% or 25%. Unlike a salary, the contribution is not subject to Employer's NICs (15%) or Employee's NICs. Furthermore, the director pays no income tax on the amount contributed. This triple tax advantage makes it a powerful tool for building wealth.

The primary consideration for directors is that the funds are not immediately accessible. Money paid into a pension can typically only be accessed from age 55 (rising to 57 from 2028), so it is a strategy for future planning, not current income needs. The contributions must also satisfy HMRC's 'wholly and exclusively' test, meaning the total remuneration package (salary, benefits, and pension contribution) must be commercially reasonable for the work performed by the director. For most owner-managers of small profitable companies, this test is straightforward to meet. There is also a limit on how much can be contributed tax-efficiently each year, known as the Annual Allowance, which should be checked before making large payments.

• Full Corporation Tax Relief: The contribution is a deductible expense, reducing the company's tax bill.
• No National Insurance: Saves the company 15% in employer NICs and the director their own employee NICs compared to a salary or bonus.
• No Income Tax: The director does not pay any income tax on the contribution received into their pension.
• Tax-Free Growth: The funds grow free of income tax and capital gains tax inside the pension wrapper.
• Access Restriction: Funds are locked in until the director reaches pension access age, making it unsuitable for short-term cash needs.
• Contribution Limits: Governed by the Annual Allowance and the 'wholly and exclusively' test for business expenses.

Worth knowing: Company pension contributions offer unparalleled tax relief for directors planning for the long term, but this efficiency comes at the cost of immediate access to the funds.

Managing a Director’s Loan: The Section 455 Tax Trap

When a director borrows money from their company and does not repay it promptly, it can trigger a punitive, temporary tax charge known as 'Section 455 tax'. This rule applies if a director's loan account is overdrawn (meaning the director owes the company money) at the end of the company's financial year, and the loan remains outstanding nine months and one day after the year-end. At this point, the company itself, not the director, becomes liable to pay s455 tax to HMRC. The tax is calculated at the dividend upper rate, which is 33.75%. This is not a penalty for the director but a significant cash flow burden for the company, as it must find the funds to pay this extra tax bill alongside its regular Corporation Tax.

The s455 tax is reclaimable, but the process is slow and creates a cash flow lock-up. A company can reclaim the tax it has paid only after the underlying director's loan has been repaid. The claim cannot be submitted until nine months after the end of the accounting period in which the loan was cleared. For example, if a loan is repaid in May 2027 (in the year ending 31 Dec 2027), the company cannot submit its claim to HMRC until October 2028. HMRC will then process the refund, which can take several more weeks or months. Directors must also be aware of anti-avoidance rules targeting 'bed and breakfasting', where a loan is repaid just before the s455 deadline and a similar sum is withdrawn shortly after. If repayments and new loans total more than £5,000, the repayment can be disregarded by HMRC, and the s455 tax will still apply.

Worth knowing: An unpaid director's loan triggers a hefty 33.75% s455 tax charge on the company, creating a significant cash flow problem until the loan is repaid and the tax eventually reclaimed.

Extracting Capital on Company Closure

When the time comes to close a solvent company that has significant retained profits, the method of extraction changes dramatically. Instead of taking income via dividends, shareholders can extract the final funds as a capital distribution through a process called a Members’ Voluntary Liquidation (MVL). An MVL is a formal, legal process overseen by a licensed insolvency practitioner, designed to wind up a solvent company's affairs and distribute its net assets to shareholders. The crucial difference is that these distributions are subject to Capital Gains Tax (CGT) rather than Income Tax. For higher-rate taxpayers, this can offer a substantial tax saving, as the higher CGT rate is typically much lower than the higher rates of dividend tax.

The key to maximising tax efficiency during an MVL is qualifying for Business Asset Disposal Relief (BADR). This relief allows eligible shareholders to pay CGT at a significantly reduced rate on qualifying gains. As of April 2026, the prompt specifies a BADR rate of 18%. To qualify, the individual must have owned at least 5% of the ordinary share capital and voting rights, and been an employee or director of the company for at least two years leading up to the date of cessation of trade. Given the standard higher CGT rate on shares of 24%, BADR provides a clear advantage. The decision to liquidate should be carefully planned, as the costs of an MVL can be several thousand pounds, making it most suitable for companies with significant cash and asset reserves to distribute.

Worth knowing: Closing a company via Members' Voluntary Liquidation allows funds to be taxed as capital, which, if eligible for Business Asset Disposal Relief, is highly tax-efficient for directors.

Identity Verification and Its Impact on Director Payments

A significant change from the Economic Crime and Corporate Transparency Act 2023 is the introduction of mandatory identity verification for all company directors and Persons with Significant Control (PSCs). From 18 November 2025, anyone being appointed as a director of a new or existing company must have their identity verified before their appointment can be registered at Companies House. Existing directors will have a transitional period to complete this process. Verification will be done primarily through a digital process linking a photo ID document (like a passport or driving licence) to the individual. This represents a fundamental shift in UK company formation and administration, moving from a system of unchecked information to one based on verified identities.

Failure to comply with identity verification will have serious consequences that indirectly affect a director's ability to be paid. An unverified director will be committing a criminal offence and risks fines and prosecution. Companies House will have the power to annotate the public register, highlighting the director's non-compliant status. While this may not directly block a bank from processing a payroll or dividend payment, it creates enormous governance risks. Board resolutions to approve salaries or dividends could be deemed invalid if passed by non-compliant directors. Furthermore, a company with unverified directors is a major red flag for banks, lenders, and insurers, potentially leading to the freezing of accounts or withdrawal of services under anti-money laundering regulations. Proper payment requires proper governance, which is impossible without legally compliant directors.

• **Who must verify?** All new and existing company directors and Persons with Significant Control (PSCs).
• **When does it start?** It is mandatory for all new director appointments from 18 November 2025.
• **How is it done?** Via a new digital service at Companies House or through an authorised third-party agent.
• **What is the penalty for non-compliance?** A criminal offence for the individual, fines, and public annotation on the Companies House register.
• **What is the impact on payments?** Invalidates corporate authority, jeopardises banking facilities, and undermines the legality of any payment authorisation.

Worth knowing: Mandatory director ID verification is a new compliance necessity; failing to comply after November 2025 could undermine the entire legal framework for authorising payments from your company.

Common questions

Official sources & further reading

This guide draws on the official guidance below. Rules, fees and individual circumstances can change; check the relevant source before acting.

• GOV.UK: Taking money out of a limited company
• GOV.UK: Director’s loans
• GOV.UK: Tax on dividends

General UK information, primarily for private companies limited by shares. This is not personalised legal, tax or financial advice. An accountant or solicitor can help apply the rules to your situation.