Contractors’ Questions: How to draw money out of a limited company?

Contractor’s Question: I have contracted for a few years through my own limited company during which time I have only ever taken the dividends-low salary mix.

As a result I've built up some cash in my business account which I now want to access. What’s the most tax efficient way to withdraw this capital from my limited company business bank account and transfer it to my personal account?

Expert’s Answer: While you can take advantage of tax relief associated with pension funds, I assume you want to take the money out as cash. There are a number of ways in which you can achieve this aim, depending upon your own circumstances, and tax should not necessarily be seen as the only factor.

Most tax-efficient way to draw cash
The most tax-efficient way to draw the money out of your limited company is by way of dividends paid to a non higher-rate tax payer which for the current year means a person earning less than £42,475.

Pay dividend to basic tax rate spouse

Notwithstanding HMRC’s dislike of 'income shifting,’ it is still possible to pay a dividend to a shareholding family member, such as a spouse, to take advantage of their basic-rate tax band. These dividends could be taken out now or you could take advantage of a future year’s basic tax rate by withdrawing dividends over a period of time. For example, if you have £40,000 of surplus funds and your spouse earns £30,000 per annum, there is potential to withdraw £10,000 per annum over four years with no further tax liability.

If there is no basic rate tax band available or you need the money sooner, there are a few further alternatives.

Contact HMRC about capital distribution

Assuming you do not have too much surplus funds built up in the company (there's no hard and fast rule to this but having less than six months turnover in surplus funds tends not to raise too many problems), and you are ceasing contracting, (for example through retirement or going permanent), it is possible to apply to HM Revenue & Customs for a concession to withdraw the surplus funds as a capital distribution, subject to a capital gains tax of 10%.

Returning contractors = Phoenix Clause

You will need prior written HMRC approval, but this can be rescinded with a so-called ‘phoenix clause’ if you go back into contracting. The effective tax rate for these withdrawals is 30%; comprising 20% company tax and 10% capital gains tax. It should be noted that all concessions including this one are being placed onto a statutory basis. HMRC are taking this opportunity to review the rules and it seems this route will only be applicable if the surplus funds are less than £4,000. If the funds are in excess of £4,000, you can achieve the same result with a formal liquidation of the company.

More ‘exotic’ methods of cash withdrawal 

Meanwhile, and despite rumours to the contrary, there are still legal tax avoidance schemes available often utilising more ‘exotic’ instruments, such as trusts and tax havens. The entry level for these schemes varies but typically starts at around £70,000. With these schemes, you will pay fees as opposed to tax and you tend to get what you pay for, when considering rates of return.

Take a loan, and the taxman takes

Finally, if you are the type of person who would rather seek HMRC's forgiveness than their permission, it is also possible, if you need the money short term, to be able to take a loan for the money from the company. However HMRC will also 'borrow' from you 25% of the loan for a minimum of one year regardless of how quickly you repay the money.

I would advise discussing your personal circumstances with a professional business tax advisor before entering into any transaction.

The expert was Martin Mckechnie, Client Services Director at The Low Tax Group, a chartered management accountancy specialist.