When running a small or medium sized business, getting your approach to remuneration and profit extraction right is essential, primarily, for most director-shareholders, this is to optimise the amount of their hard-earned money they get to keep and not give away to the taxman.
Most directors understand the basics of drawing a salary and taking dividends, but with recent changes to tax rates and reductions in allowances, the most optimal strategy can be a little more difficult to plan.
Effective planning should look at the most tax-efficient approach from both the company’s and the individual’s perspective, while also factoring in company profits, cash flow, incentivising employees and administrative responsibilities.
This article builds on our guide to directors’ remuneration by diving deeper into some of the areas introduced in that article and highlighting some of the other methods director-shareholders can utilise to make the most of their company’s distributions and remuneration.
Table of Contents
Understanding the distribution landscape
Company distributions come in various forms. The two most common and generally used in conjunction are:
Salary
Paying yourself a salary through your company’s payroll is a straightforward and common part of a director’s remuneration strategy. Because it’s classed as employment income, it reduces your company’s Corporation Tax (CT) bill by lowering taxable profits. However, salary isn’t just about tax, it also helps you build up National Insurance (NI) credits, which count toward your State Pension and other entitlements. On top of that, taking a salary gives you access to statutory benefits like sick pay and maternity/paternity leave, and it allows the company to make employer pension contributions without needing you to have any personal “relevant earnings.”
When deciding how much salary to take, it’s worth thinking strategically. A good starting point is setting it at least at the Lower Earnings Limit (£6,396 for 2024/25), which gets you those valuable NI credits without having to actually pay any NI. Many directors go further and pay themselves up to the Primary Threshold (£12,570), which uses up their personal tax allowance and keeps NI costs low or even nil with the right setup. However, if the company wants to avoid employer NIC altogether, particularly in lower profit or single director setups, then keeping salary at the Secondary Threshold (£9,100) can be a more efficient option. It’s all about finding the right balance between tax efficiency and benefit entitlement.
The low salary can then be topped up by taking dividends.
Dividends
Dividends are still one of the most tax-efficient ways for director-shareholders to take money out of their company, even though HMRC are not quite as generous as they once were. Over the years, dividend tax rates have crept up and the dividend allowance has shrunk to just £500 for the 2024/25 tax year. This is a big drop from the original £5,000 allowance when it was first introduced. That said, with the right planning, dividends can still play a valuable role in a well-rounded remuneration strategy.
There are a few important rules to keep in mind. Dividends can only be paid from the company’s accumulated post tax profits, and they are not deductible for CT purposes. To be valid, they need to be properly declared and documented, that means board minutes, accurate records, and up-to-date accounts showing there are enough retained profits available.
Dividends also have to be paid in proportion to shareholdings, unless the company has set up alphabet shares (like A, B, C shares), which offer more flexibility. If these formalities aren’t followed, HMRC could reclassify dividends as salary, bringing with it unexpected tax and NI liabilities.
That’s why we always recommend timing and structuring dividends carefully. Making the most of the £500 allowance and staying within the basic rate tax band can really help keep the tax bill down. And for those looking to split income across family members or co-owners, alphabet shares can be a smart move. They allow you to tailor dividend payments in a more tax-efficient way without needing dividend waivers each time. As always, good planning and proper records are key.
There are downsides to the dividend route:
- Dividends are not deductible for the company for corporation tax purposes
- Dividends are not earnings for pension purposes thereby potentially reducing the individual’s capacity to make pension contributions
We next look at some of the other less common methods of extracting funds from a business.
Employer pension contributions
One of the most tax-efficient ways for directors and shareholders to extract funds out of their company is through employer pension contributions. Unlike dividends, pension contributions made by the company are usually deductible for CT purposes and do not attract NI, making them a very attractive option. They not only help directors build long-term personal wealth but also reduce the company’s overall tax bill. Plus, pension contributions can be a great way to defer personal tax while taking profits out of the business efficiently.
Directors might use salary sacrifice schemes or have the company contribute directly to their pension.
Under the salary sacrifice scheme, the individual gives up a portion of their salary and the employer pays it into the pension. The sacrificed amount is not subject to Income Tax or NI, which saves money for both the employee and the company.
Alternatively, the company can pay directly into the director’s pension pot, claiming a reduction in their CT.
The main thing to keep in mind is the £60,000 annual limit (or less if tapering applies for higher earners).
That said, it’s important to plan pension contributions carefully alongside your company’s cash flow and profits. To get the tax relief, contributions have to be genuinely for the business and not excessive. They need to make commercial sense given the director’s role. If payments seem irregular or unusually large, they will attract greater scrutiny from HMRC. Pension planning should fit into your wider strategy, balancing salary, dividends, and benefits to get the most tax-efficient outcome that works for your personal financial goals.
One thing that often confuses people is the idea that you need enough “relevant earnings” to justify pension contributions. That rule only applies if you are making personal contributions yourself. When the employer makes the pension contribution, there’s no need for the director to have a specific salary or level of earnings. From a personal tax point of view, employer contributions aren’t tied to their salary or dividends. The key limit to watch is the Annual Allowance (AA). If this is exceeded, a tax charge would be levied at the individual’s marginal rate. To counter this, any unused AA from the three earlier years on a first in first out (FIFO) basis can be used.
Pension contributions are tax efficient however, they do not give you immediate access to the funds and so may not be a viable approach on its own if you need the funds now.
Bonuses
Bonuses can be a flexible tool in the remuneration toolkit, particularly for director-shareholders who want to reward performance or extract additional profits in a controlled way. From a tax perspective, bonuses are similar to a salary in that they are tax deductible if they are incurred wholly and exclusively for the purposes of the trade and properly accrued in the accounts. However, like salaries, they do attract both income tax and employer/employee NI contributions, making them less tax-efficient than alternatives like pension contributions or dividends.
Unlike salaries, bonuses are only payable in return for exceptional performance meaning the individual does not have a right to them and the company does not have a regular obligation to pay them.
That said, bonuses can be strategically useful in certain circumstances, especially when profits need to be reduced before a year end or when PAYE salary levels are low and there is room to increase personal taxable income without tipping into higher tax brackets.
For companies looking to manage distributable reserves or signal performance based rewards, well timed bonuses can also support staff motivation and retention. As with any remuneration planning, it is important to consider timing, tax thresholds, and the overall impact on both corporate and personal finances before committing to a bonus strategy.
Director loans and repayments
Director loan accounts can play a significant role in remuneration and distribution planning, particularly in smaller owner managed businesses where the line between personal and company finances can easily blur. A director may lend money to the company or withdraw funds that aren’t salary, dividends, or expense reimbursements, creating what’s known as a director’s loan. While such flexibility can be helpful for short-term cash flow management, improper use can lead to tax complications.
If a director withdraws funds from the company and the loan is not repaid within nine months of the company’s year end, the company becomes liable to a temporary corporation tax charge (known as a section 455 charge) at 33.75% of the outstanding amount. This charge is repayable once the loan is cleared, but it can create cash flow strain.
Additionally, if the loan exceeds £10,000 at any point and isn’t repaid promptly, a benefit-in-kind charge may apply to the director, and the company must account for Class 1A NIC. As best practice, directors should ensure that any loans are either repaid on time or formally written off and treated as dividends (subject to the availability of distributable reserves). Clear documentation, timely repayments, and alignment with broader profit extraction strategies are key to avoiding unexpected tax consequences.
If the director lends money to the company and charges interest. The interest received is chargeable to income tax but is not earnings for NIC purposes (again enabling an NIC free extraction).
The interest payments are normally deductible for the company under the loan relationships rules. Where a UK company pays interest to an individual, it must withhold 20% income tax at source.
Benefits-in-kind
Benefits-in-kind (BIKs), such as company cars, private medical insurance, or interest-free loans, are another form of non-cash remuneration that director-shareholders may consider as part of their overall remuneration strategy. While these perks can be attractive and tax-efficient in certain scenarios, they are generally subject to income tax on the individual and Class 1A NIC payable by the company. The taxable value of the benefit determined by HMRC rules must be reported via the annual P11D process or through payrolling benefits, if opted for (mandatory from 2027/28).
From a planning perspective, it’s important to weigh the cost of providing the benefit against the tax implications for both the company and the director. E.g., the provision of an electric company car may result in a relatively low BIK charge compared to a traditional petrol vehicle, making it a tax-efficient incentive. Similarly, providing private medical cover might be worthwhile for peace of mind and recruitment, even if there’s a modest tax cost. When used thoughtfully, BIKs can complement salary, dividends, and pension contributions to create a balanced and tax-optimised remuneration package. However, they should be reviewed regularly to ensure they remain aligned with both business and personal tax objectives.
Rent
If the director-shareholder owns a property which the company uses in its trade, rent could be charged to the company for the use of that property.
The rents (less any allowable expenses) are chargeable to income tax but are not earnings for NIC purposes (thereby enabling an NIC free extraction).
The rental payments are deductible for the company for corporation tax.
Compared to other forms or extraction, this method is not as tax efficient because:
- The income is taxable at the non-savings rates of 20%, 40% or 45% – making it more expensive than taking a dividend; and
- When the property is sold in the future, any gain will not be fully eligible for business asset disposal relief (BADR). The NICs saving obtained by extracting money by way of rent is therefore often given back to HMRC by way of a higher CGT charge on a disposal of the building.
Liquidation
We increasingly advise director-shareholders extracting funds via formal liquidation. In a Members’ Voluntary Liquidation (MVL), remaining company funds are distributed to shareholders as capital rather than income for tax efficiency.
Where CGT treatment applies, distributions may qualify for BADR at 14% from April 2025, often significantly lower than income tax or dividend rates.
However, HMRC’s Targeted Anti-Avoidance Rule (TAAR) prevents abuse where directors liquidate, take funds as capital, then establish a new company in the same trade. If TAAR applies, distributions are reclassified as income, taxed at up to 39.35%.
TAAR may be triggered where the individual is involved in a similar trade within two years of liquidation, one main purpose was securing tax advantage, and the distribution would otherwise be taxed as income.
When used appropriately on retirement or genuine trade exit, liquidation can be highly tax-efficient. However, if used to avoid tax while continuing the same business, consequences include tax reclassification, penalties, and backdated liabilities.
Careful planning and clear documentation of commercial intentions are critical. Professional advice is essential for compliance. HMRC offers a clearance process we can assist with.
Final thoughts
Remuneration and distribution planning goes far beyond simply reducing tax bills. It’s about aligning the director’s personal income needs, the company’s financial health and its long-term objectives. A well-structured strategy can strike a balance between extracting profits efficiently and reinvesting in business growth, while also supporting areas like retirement planning, cash flow management, and risk reduction. E.g., combining salary, dividends, pension contributions, and benefits-in-kind in the right proportions can help minimise tax exposure while ensuring directors are adequately compensated and protected.
However, there is no one-size-fits-all approach. What works well for one SME may be wholly inappropriate for another due to differences in business structure, profitability, shareholder makeup, or cash reserves. That’s why seeking professional advice is recommended. The qualified team of specialists at Gravita work closely with SMEs to help them get the most out of their director remuneration. We can tailor a plan to suit the specific goals and constraints of both the business and its directors, ensuring compliance with tax law while maximising efficiency.
In a landscape that is constantly evolving, ongoing planning and review are just as important as the initial setup.
Need help structuring your remuneration strategy? Talk to our accounts specialists to get tailored, expert advice.
