Tax efficient profit extraction

Where a business is operated through a personal or family company, profits must be extracted it they are to be used by the directors/ shareholders personally. There are various ways in which this can be done, and the route taken will determine any further tax and National Insurance contributions that may be due.

At the start of the new tax year, it is important to review the profit extraction strategy to ensure that it remains tax efficient. Tax changes may mean what worked last year is no longer the best route this year. It is important to take account of any changes in tax rates and thresholds. Of particular relevance for 2026/27 are the rise in the ordinary and upper dividend tax rates by two percentage points to respectively, 10.75% and 35.75%, and the increase in the lower earnings limit for Class 1 National Insurance.

Salary

It can be beneficial to take a small salary which is sufficient to ensure that the year is a qualifying year for state pension purposes. Where the recipient does not already have the 35 qualifying years needed to secure a full state pension, this is a valid consideration. Taking a small salary when the personal allowance remains available can be a tax-efficient way to extract profits.

For the salary to provide a qualifying year, it must be at least equal to 52 times the weekly lower earnings limit, which for 2025/26 is £6,708 (52 x £129).

This is slightly higher than the 2025/26 figure of £6,500. Consequently, where a salary is paid which is equal to the lower earnings limit, it will be necessary to increase the salary as we move into 2026/27. Although there will be no tax or primary Class 1 contributions to pay on a salary of this level, as the secondary threshold is below the lower earnings threshold (£5,000 for 2026/27), there will be secondary contributions of £252.60 on a salary of £6,708.

Salary payments and employer’s National Insurance contributions are deductible in calculating the company’s profits for corporation tax purposes.

This means that it can be worthwhile paying a higher salary, even if there is some employer’s National Insurance to pay.

Where the Employment Allowance is available, as may be the case in a family company, as long as the personal allowance has not been used elsewhere, it is possible to pay a salary of £12,570 (equal to the personal allowance and primary threshold) free of National Insurance and tax. Beyond this level, the combined tax (at 20%) and primary Class 1 National Insurance (at 8%) hit will outweigh any corporation tax relief (at between 19% and 25%), making a salary of £12,570 the optimum salary for someone with a personal allowance of £12,570.

In the absence of the Employment Allowance, it is still worthwhile paying a salary of £12,570 as the corporation tax relief will outweigh the employer’s National Insurance hit.

Where the personal allowance is not £12,570, it will be necessary to crunch the numbers to find the optimal salary. A higher salary may be beneficial if the recipient benefits from the marriage allowance and the company benefits from the Employment Allowance.

Dividends

Once a salary has been paid which is equal to the personal allowance of £12,570 for 2026/27, if further profits are needed outside the company for personal use, it is more tax efficient to take them as dividends. This is because there is no National Insurance to pay on dividends and the dividend rates of tax are lower than the standard income tax rates. However, as dividends are paid from post-tax profits, it is important to remember that they have already suffered corporation tax of between 19% and 25% depending on the rate at which the company pays tax.

Paying dividends is not as straightforward as paying a salary because there are rules which must be met.

A company can only pay a dividend where it has sufficient retained profits from which to pay it. Where there is more than one shareholder for a class of share, dividends must be paid in proportion to shareholdings.

However, where the company has an alphabet share structure (so each shareholder has their own class of share), dividends can be tailored to the circumstances of the shareholder to allow profits to be paid out as dividends in a tax efficient manner.

For 2026/27, all taxpayers still have a dividend allowance of £500, regardless of the rate at which they pay tax. Paying dividends to utilise shareholders dividend allowances where these are not used elsewhere allows profits to be extracted without any further tax being payable.

The dividend allowance acts as a zero-rate band, with dividends falling within this band being taxed at a zero rate.

Once the dividend allowance (and any unused personal allowance) has been used up, dividends are taxed at the dividend ordinary rate when they fall within the basic rate band, at the dividend upper rate if they fall within the higher rate band and at the dividend additional rate if they fall within the additional rate band. For 2026/27 the dividend ordinary rate is 10.75% (up from 8.75% for 2025/26), the dividend upper rate is 35.75% (up from 33.75% for 2025/26) and the dividend additional rate is unchanged at 39.35%.

This rise in the dividend ordinary and upper rates will reduce the amount that the shareholder gets to keep where the dividend falls in the basic or higher rate band.

For example, if a director of a personal company takes a salary of £12,570 and receives a dividend of £37,700 to use up their basic rate band, they will pay £744 more in tax on that dividend than in 2025/26.

Pension contributions

If funds are not needed immediately, it can be tax effective for the company to make pension payments on the director’s behalf. Pension contributions are not a taxable benefit, and the company is able to deduct them in calculating their profits for corporation tax purposes.

Although contributions made by an employer count towards the annual allowance, the 100% of earnings cap (or £3,600 if higher) that limits personal contributions does not apply. As dividends do not count as earnings for pension contribution purposes, this may mean that a director can only make contributions of up to £12,570 a year, whereas the company is able to make higher contributions up to the level of the available annual allowance. For 2026/27, the annual allowance is set at £60,000 (tapered for high earners). Once this has been used, contributions can also be made to use up any available allowances from the previous three tax years.

Benefits in kind

There are a number of exemptions which allow a company to provide benefits tax free. Examples of tax-free benefits include the provision of a mobile phone, an annual health check, workplace parking, trivial benefits costing up to £50 each (capped at £300 per year for participators in a close company, and suchlike.

Rent

Many small companies are run from a home office. This provides the option for the company to pay rent to the director for the use of the space. While this will be taxable in the director’s hands, unlike salary payments there Is no National Insurance to pay. It should be noted that the director cannot benefit from the £1,000 property income allowance here.

Also, from a capital gains tax perspective, it is advisable that the space used by the company is not used exclusively for business use.

Leave the profits in the company

Profits do not need to be extracted, and where extracting them would trigger tax and National Insurance bills, they can simply be left in the company until needed.