During November’s Facebook Live, I focused on small, limited companies. I clarified two key ways of taking money out of the business. I explained the rules and tax implications of director’s loans (including the £10,000 threshold and s445 tax), and contrasted it with the process and tax efficiency of paying dividends.
One of the first things to understand about limited companies is that they are a separate legal entity from the directors and shareholders. Unlike a sole trader, you cannot just take money out of the business anytime you like, as that money does not belong to you; it belongs to the limited company. To withdraw money from the limited company, you need to either take it as a salary through the PAYE scheme, where you are an employee of the limited company, or through the two options I will be discussing today – director’s loan and dividends.
Dividends: A Share of the Profits
Let’s start by explaining what dividends are. Dividends are a payment a company makes to its shareholders if it has sufficient post-tax profits. They are used as a way for companies that are profitable to reward their shareholders for investing in the company. As dividends are reliant on the business being profitable, dividends are not a mandatory payment. A company must ensure that it is not paying out more in dividends than the available profits from the current and previous financial years. The amount paid can also be changed at any point in time, or even suspended, depending on the company’s financial situation.
Dividends can only be paid to shareholders if they have been declared properly within a board meeting, with it noted in the meeting minutes. After the dividends have been declared, the proper paperwork must be created, which is called a dividend voucher. It must show the date, company name, the names of the shareholders being paid a dividend, and the amount to be paid. A copy of the voucher needs to be given to the recipient, and a copy kept by the company. The most common type of dividends is a cash dividend, but companies could also choose to issue additional shares to their shareholders.
How are Dividends affected by Tax?
Neither the company nor the director has to pay National Insurance on any dividends received. However, the director must pay income tax on dividends that exceed the current £500 dividend allowance for the 2025/2026 tax year. An individual’s personal allowance, currently £12,750, is also taken into account.
Once your dividends go beyond these allowances, they are taxed according to your personal tax band:
Basic Rate taxpayers: 8.75% on dividends
Higher Rate taxpayers: 33.75% on dividends
Additional Rate taxpayers: 39.35% on dividends
From April 2026, the tax on dividends will go up by 2% for basic and higher rate taxpayers:
Basic Rate taxpayers: 10.75% on dividends
Higher Rate taxpayers: 35.75% on dividends
Additional Rate Taxpayers: 39.35%
In summary, you only start paying tax on dividends after your allowances are used, and the rate depends on your income tax band.
Director’s Loans: Borrowing from Your Company
Now, let’s talk about directors borrowing money from their company and how that compares to dividends.
A Director’s Loan Account (DLA) is simply a record of money moving between a company and its director. Think of it like a tab that keeps track of:
- Money the director puts into the company (the company owes the director) and
- Money the director takes out of the company that isn’t salary, dividends, or expenses (the director owes the company).
It’s not a physical account, just a running total of who owes whom.
Here is an example: imagine you and your friend run a small business. You each have your own personal money, and the business has its own money.
- One day, you pay a business bill with your personal cash. The business “owes” you. It goes on the director’s loan account.
- Another day, you take some money from the business to pay for something personal. Now you “owe” the business. That also goes to the director’s loan account.
At any point, the running total tells you:
- Positive Balance: the company owes the director.
- Negative Balance: the director owes the company.
Why is a Director’s Loan Account Important?
As a company is legally separate from the director, any money flowing between them has to be tracked properly. The DLA keeps everything clear and avoids tax complications or accidental misuse of company money.
What are the tax rules if a director owes the company?
Has anyone found the Director’s Loan Account rules confusing in the past? Share your answer in the comments.
If there is a negative balance on the DLA at the end of the tax year, the director owes the company money. As long as that balance is repaid within 9 months and one day of the company’s year-end, there are usually no tax issues for the company.
However, if the amount is not repaid to the company within that time frame, the company must pay Corporation Tax on the amount owed at 33.75%. This is known as s455 tax. Once the loan is repaid, the company can claim back the tax that was paid, though this may take some time. It is important to note that if a loan of £5,000 or more is repaid and then re-borrowed within 30 days, the repayment is disregarded, and the tax charge will still apply. If the loan amount is more than £10,000 in a tax year, a benefit-in-kind charge may also apply. The director must report the loan on a P11D form, and the company must report Class 1A National Insurance contributions using form P11D (b) by July 6th, and then pay the amount due. A benefit-in-kind is a non-cash benefit provided to an employee that has a cash value and is taxable.
If the company has charged the director interest on the loan, they must report that to HMRC, and the company must deduct tax at source at a rate of 20%.
The rules around Director Loan Accounts for companies can become quite complicated depending on how old the loan is, when it was initially issued, when it was repaid or if it was written off. You can read more about the tax implications and responsibilities of both the company and the director who owes the money on the government website.
What happens if the Company owes the Director?
If you have lent money to the Company, the tax situation is fairly simple. The company does not pay Corporation Tax on the amount you lend. If you charge the company interest, that interest is treated as a business expense for the company and as personal income for you. You must include this interest on your self-assessment tax return. The company must pay you the interest after deducting basic-rate income tax (20%), and then report and pay that tax every quarter using form CT61.
Key Comparison and Best Practice
The key difference between dividends and DLA is that dividends are a distribution of profit, and loans are borrowing.
The most tax-efficient way for directors when comparing dividends and DLA is to take a small salary as well as dividends. The small salary keeps things like state pension credits active and can be counted as an allowable company expense. The rest as dividends reduces the total tax bill because the tax on dividends is lower. This combination means the director takes home more money, while the company pays less tax overall, all completely legally.
However, that doesn’t mean that directors’ loans don’t have their place. They can be useful for short-term needs, but they can get complicated and expensive if they aren’t managed carefully. Always make sure you keep meticulous records relating to Director’s Loan Accounts.
Getting your remuneration strategy right is key to being tax-efficient and compliant. If you’re a director and unsure about the best way to take money from your company, please feel free to email me to book a consultation. We can review your specific situation and ensure your bookkeeping is watertight.