Money you take out of your own limited company is taxed as one of three things: salary, a dividend, or a director’s loan. Salary carries income tax and National Insurance for both you and the company. Dividends skip National Insurance but come from profit the company has already paid corporation tax on. A director’s loan is anything else you draw, and if you don’t repay it in time the company faces a separate tax charge. The tax on drawings from a limited company depends almost entirely on which of these three buckets each pound falls into, and most owner-directors mix a low salary with dividends to keep the overall bill down.
How Salary Is Taxed
Salary and bonus payments go through PAYE, so income tax comes off before the money reaches you. For 2026/27, the personal allowance is £12,570. Above that, income tax runs at 20% within the basic rate band (the next £37,700), 40% in the higher rate band up to £125,140, and 45% beyond.
National Insurance sits on top. You pay employee Class 1 NIC at 8% on earnings between £12,570 and £50,270, and 2% on anything higher.1GOV.UK. National Insurance Rates and Categories – Contribution Rates The company then pays employer NIC at 15% on everything above the secondary threshold, which dropped to just £5,000 in April 2025 and is locked there until 2031. That change made paying salary noticeably more expensive.
Employer NIC is the reason salary looks unattractive compared with dividends. It isn’t recoverable, though eligible companies can offset up to £10,500 through the Employment Allowance.2GOV.UK. Employment Allowance – What You’ll Get Salary does have one advantage: the company can deduct it against its corporation tax bill, which dividends can’t do.
How Dividends Are Taxed
Dividends are distributions of company profit to shareholders, and because the profit has already been taxed at the company level, dividends carry no National Insurance for you or the company. That single fact drives the whole salary-versus-dividends question.
You get a £500 dividend allowance each tax year regardless of your total income. Above that, dividend tax rates depend on which income tax band the dividend income sits in: 8.75% for basic rate taxpayers, 33.75% for higher rate, and 39.35% for additional rate.3GOV.UK. Tax on Dividends
The condition that trips people up is that dividends can only come from distributable profits. The company must have enough accumulated post-tax profit to cover the payment. If it doesn’t, the dividend is unlawful, and the tax and legal fallout is significant. Before declaring a dividend, check the company’s financial position and record the decision in board minutes or a written resolution.4GOV.UK. Company Taxation Manual – CTM15205 – Distributions: General: Dividends, Distributions and Company Law
Why Corporation Tax Matters to the Dividend Calculation
The headline dividend rates hide the corporation tax the company has already paid on that profit. The main rate is 25% for companies with profits above £250,000. Companies with profits of £50,000 or less pay 19%, and marginal relief applies between those thresholds, sliding the effective rate up from 19% towards 25%.5GOV.UK. Corporation Tax Rates, Expenses and Reliefs
Layer the two together and the picture changes. A basic rate taxpayer taking dividends from a company on the 19% small profits rate faces a combined effective tax of roughly 26%. If the company pays the full 25% rate, the combined burden on a basic rate taxpayer rises to about 32%. Dividends still beat salary at every income level because they avoid NIC, but the margin is smaller than the 8.75% headline suggests.
The Low Salary Plus Dividends Approach
Most owner-directors set a salary at or just below the £12,570 primary threshold and take the rest as dividends. At that level you pay no employee NIC while still earning qualifying years toward your state pension, which requires earnings above the lower earnings limit of £6,708. The company pays 15% employer NIC on the portion above the £5,000 secondary threshold, so on a £12,570 salary the employer NIC bill is around £1,135 a year.
That NIC cost is partly offset because the salary itself reduces the company’s corporation taxable profit. This is why paying zero salary is rarely the optimal choice. The best split depends on your profit level, whether you have other income, and whether the Employment Allowance is available, but the general rule holds: salary up to the point where NIC starts outweighing the corporation tax saving, then dividends after that.
Director’s Loans and the Section 455 Charge
Anything you take from the company that isn’t salary, a dividend, or a genuine expense reimbursement lands on your director’s loan account. If you still owe the company money nine months and one day after the end of its accounting period, the company must pay a charge under Section 455 of the Corporation Tax Act 2010 at 33.75% of the outstanding balance.6Legislation.gov.uk. Corporation Tax Act 2010 – Section 455
S455 is refundable, not permanent. When you repay the loan, the company can reclaim the tax. If repayment happens within the nine-month window, the S455 charge never actually falls due. If it happens later, the company pays first and reclaims relief nine months after the end of the accounting period in which repayment occurred.7GOV.UK. Company Taxation Manual – CTM61610 – Date Relief Is Due The delay between paying the tax and getting it back can strain the company’s cash flow.
Outstanding director’s loans are reported on the company’s CT600, and HMRC uses that entry to check the S455 position.8GOV.UK. Company Taxation Manual – CTM61505 – Close Companies: Loans to Participators
The 30-Day Rule
Repaying a loan just before the S455 deadline and then borrowing the same money back used to be a common workaround. HMRC shut it down. Where repayments of £5,000 or more and new loans of £5,000 or more happen within any 30-day period, the repayment is treated as clearing the new loan, not the old one. The original balance stays outstanding and the S455 charge applies.9GOV.UK. Company Taxation Manual – CTM61630
Interest-Free Loans Over £10,000
If your director’s loan goes above £10,000 at any point in the tax year and the company charges you no interest, or less than HMRC’s official rate, you have a taxable benefit in kind. The official rate from April 2026 is 3.75%.10GOV.UK. Beneficial Loan Arrangements – HMRC Official Rates The benefit is the interest at the official rate minus what you actually paid. You owe income tax on it, and the company owes Class 1A NIC at 15%.1GOV.UK. National Insurance Rates and Categories – Contribution Rates These charges stack on top of any S455 exposure, which is why sizeable balances left on the loan account become costly quickly.
Dividends Declared Without Enough Profit
If the company declares a dividend it doesn’t have distributable reserves to cover, the payment is unlawful. HMRC will usually reclassify the shortfall as a director’s loan, pulling it into the S455 regime. Directors who knew or should have known that profits were insufficient can be personally liable to repay the company the full unlawful amount, so the company’s creditors are protected.
This happens more often than you’d expect, particularly where directors work from management accounts that haven’t been squared to a proper profit and loss position. Before any significant dividend, prepare interim accounts and have your accountant confirm the reserves are there.
Reporting Deadlines and Penalties
Each type of drawing has its own reporting obligations, and HMRC applies penalties strictly.
- Self Assessment. File your personal return by 31 January following the end of the tax year to report dividend income and any taxable loan benefits. Miss it and you get an immediate £100 penalty, then £10 per day for up to 90 days after three months, a further 5% of tax due or £300 (whichever is higher) at six months, and another 5% or £300 at twelve months.11GOV.UK. Self Assessment Tax Returns – Penalties
- P11D. Report benefits in kind, including interest-free loans, by 6 July after the end of the tax year. Late filing costs £100 per 50 employees per month or part month.12GOV.UK. Expenses and Benefits for Employers – Deadlines
- CT600. The corporation tax return is due twelve months after the accounting period end, but any S455 tax is payable at nine months and one day, well before the return itself.
- PAYE. Monthly Full Payment Submissions for salary are due on or before each payday, and late or incorrect submissions can attract penalties and interest.
The most common mistake is treating you and the company as one taxpayer. HMRC treats you as two. An unreported dividend on your personal return can prompt an enquiry into the company’s records as well. Keeping the two sets of obligations separate is part of the cost of running a limited company.