You will typically have three main relationships with your business: as a lender, an employee, and as an owner/shareholder.
Based on these relationships here are the five ways you can draw money from your business:
a- As a Lender to your business
1. Director’s Loan
If you have lent money to the business for any reason then this is considered a loan like any other loan, and as such it is payable back to you.
The advantage: the cash you will receive personally as a loan repayment is not subject to personal tax.
b- as an employee of your business
As you work in your business you can earn an employee’s salary. Keeping the salary low can help to keep the tax costs to you and your business at a minimum.
For example you could pay yourself up to the limit of National Insurance (NI) threshold [2014/15 Employee NI £153 pw] or up to the director’s annual personal allowance [2014/15 personal basic allowance is £10,000 per year].
The advantage: salary is a tax deductible cost to a business thereby reducing your corporation tax. Also, under the threshold you will not incur personal tax.
3- Reimbursable Expenses
You may incur expenses in your business which you pay personally. As long as the expenses were exclusively for business, you can claim them back from the business.
In addition HMRC allows for using some personal assets for business; e.g. if travelling in your own car for business purposes, you can claim 45p per mile without incurring income tax. There are also allowances for the use of your home if working from home.
The advantage: as long as expenses are allowable there will be no personal tax liability and you will get reduction in corporation tax.
A company will pay 20% corporation tax on profits. The profit-after-tax is then available to distribute to its shareholders. This is called dividends.
If you pay yourself a dividend, up to the basic rate income level [the 2014/15 basic rate at 20% is £31,865], you will not have to pay additional personal taxes.
Once your gross personal income goes over the basic income threshold, the tax rates fordividend income also go up.
The advantage: dividends give businesses the flexibility of keeping salary costs low and paying shareholders after earning actual profits, allowing owners to earn in the most tax-efficient way.
5- Capital Gains
Capital gains occur when, as a shareholder, you sell your shares to someone at higher than cost value.
The capital gains tax rate starts from 18% [2014/15 Gains to Basic rate Limit 18%, Gains above basic rate 28%]. However, there is an annual exemption available for the first £11,000 [2014/15 individual allowance]. Also, if you qualify for Entrepreneur’s Relief you will only have to pay 10% capital gains tax.
The advantage: tax liability is lower than income tax.
As a small business owner, you have multiple options to get returns from your own managed business. HMRC rules can be complex and the rates and allowances are subject to change each year. An accountant or a financial advisor can help you decide between options, to ensure that your decisions reflect the choice most economical and advantageous to your business.