When you set up your limited company, you may think you can dip into your company’s monies, as and when you like, as it is your cash! Unfortunately, this approach is wrong and can often lead to financial problems for directors of troubled companies.
When a limited company is incorporated at Companies House, it becomes a legal entity in its own right. This means the assets and profits belong to the company rather than the owners or shareholders. So, you are not able to take money out of the business in the same way that a sole trader can. Sole traders are, effectively, the business so it is their money and their debts. Limited liability is one of the main benefits of forming a company, as directors are not automatically personally liable for the debts of the company, as is the case for a sole trader or partnership.
Although it may sound like we are being pedantic, most small company directors need to stop merging the company and themselves together in their minds. This is plain wrong.
You as a person, when acting as a director are NOT the company! As a designated member you are not the limited liability partnership either. You are an ‘officer of the company’.
Likewise, the company assets and company debts are not (generally) yours personally either. So, it is vital to recognise that there are four parts or “constituencies”, to every limited company.
It is important to separate these constituencies:
- The Company
- The Business
- The Directors
- The Shareholders or Members
The COMPANY is a legally recognised entity that you can set up to run your BUSINESS. It is responsible in its own right for everything it does and its finances are separate to the DIRECTORS OR SHAREHOLDERS personal finances.
Any profit it makes is owned by the company, NOT BY THE DIRECTORS (after corporation tax). The company can then share its profits with the SHAREHOLDERS/MEMBERS if the directors decide it is appropriate to do so. This is not the same as directors’ wages or salary.
NB any profit the company makes is NOT DIRECTLY YOURS as a director or employee.
How can money be taken out of a company legally?
There are three ways in which money can be taken out of a limited company.
- Director’s loan
- Director’s salary, expenses and benefits
If you use these methods in combination, this may be a tax efficient way to minimise personal tax liabilities and run a business. Corporation tax is only 19% (but announced in The Spring Budget 2023 that it will rise to 25% on taxable business profits after £250,000 from April 2023), compared to income tax at 25-45%, but taking money out of a company in the form of dividends is subject to income tax AFTER corporation tax has been paid. There is no way to escaping paying tax completely, but the situation you are in can determine if you can benefit from more or less tax efficient methods.
Directors tend to be shareholders in profitable companies who pay taxes and have a cash buffer. When this is the case, dividends are able to be distributed as a means of taking out income, from retained profits (or that buffer). Corporation tax is deducted first.
However, for dividends over £2,000 pa shareholders have to pay income tax depend upon the rate of tax they normally pay – for example the web site https://www.gov.uk/tax-on-dividends explains
|Tax year||Dividend allowance|
|6 April 2022 to 5 April 2023||£2,000|
|6 April 2021 to 5 April 2022||£2,000|
|6 April 2020 to 5 April 2021||£2,000|
|6 April 2018 to 5 April 2019||£2,000|
Working out tax on dividends above your allowance
The tax you pay depends on which Income Tax band you’re in, as per below.
Please note, as of April 2022, the tax on dividend income will increase by 1.25% to help support the NHS and social care
|Tax band||Tax rate on dividends over your allowance|
Add your income from dividends to your other taxable income to work out your tax band. You may pay tax at more than one rate.
Dividends that fall within your Personal Allowance do not count towards your dividend allowance.
You get £3,000 in dividends in the 2020 to 2021 tax year. The dividend allowance is £2,000, so this means you pay tax on £1,000 of your dividends.
Your other taxable income is £35,000. Add this to your dividends of £3,000 and your total taxable income is £38,000.
You pay a rate of 7.5% on £1,000 of dividends because your total taxable income is within the basic tax band.
KSA is not a tax advisor. You should take advice from tax experts before doing this.
This method can be efficient so long it is handled correctly. A director’s loan account records all of the transactions, between a director and the company itself. The account balance can be ‘in credit’, if the director has paid more into the company than taken out, or ‘overdrawn’, if the director withdraws more than paid in.
All transactions in the director’s loan account should be accounted for in the company’s balance sheet and included in the company tax return and director’s self-assessment return. Generally, when directors have overdrawn loan accounts, they do not have to pay tax, so long that the sum is repaid to the company within 9 months and one day of the accounts reference date. If the directors loan account is overdrawn by more than £10,000 the sum has to be declared on the director’s self-assessment tax return with the appropriate amount of tax. You should take advice from tax experts before doing this.
Beware of repaying loans you have made to an insolvent company, this could be a breach of s239 Insolvency Act 1986. Speak to us for guidance on this “preference “risk
Directors Salary Through PAYE
This tends to be the most obvious method; directors pay themselves a salary. As well as this, expenses and bonus payments can be taken out. Directors must ensure they are employed as an employee of their company and their salary is paid via PAYE. Not all directors will take a large salary – some prefer a smaller salary and taking a larger share of their pay in dividends instead. You should take advice from tax experts before doing this.
If an employee makes personal use of a company asset, such as property or a car, this should be reported as a benefit in kind, with any tax paid. All company directors have to prepare a tax return under Self-Assessment rules.
A salary up to the NIC threshold can be taken out tax free. So, no income tax or NIC needs paying but eligibility for the state pension will remain. Alternatively, a salary equivalent to the personal allowance level of £12,500 can be taken. No income tax needs paying, however a class 1 National Insurance contribution of 12% will need deducting from salaries between £8,632 and £12,500. You should take advice from tax experts before doing this.
What if the company is struggling?
If you cannot pay your WRONG the company cannot its taxes or creditors, the company may not be viable. In these cases, drawings should not be taken. If they are taken under these circumstances, the directors are just building up a negative balance which will need repaying if the company becomes insolvent and enters liquidation, pre-pack administration or company voluntary arrangement. The problem will not go away either – so don’t think you can just bury your head in the sand. HMRC may start to investigate and penalties may be charged. If the company goes into liquidation then you are a debtor of the company and the liquidator will be able to recover money from you and go after you personally. If you have taken out excessive amounts or acted badly then you may be disqualified as a director as well.
A word of warning.
Remember that accountants will often advise you to take out dividends as they are tax efficient. However, if you don’t talk to them regularly or they are just involved in the year end accounts they are not duty bound to tell you to stop if the company starts making big losses. The direct debit into your own bank account could just carry on storing up problems for you in the future.
What if I want to close the company and take the money out?
Finally, if the company has no further use and you wish to close it but it has money and assets, then the correct way to do this, if the assets are more than £25,000, is via a Members Voluntary Liquidation.
If you are in need of some professional, helpful advice or a discussion regarding repaying overdrawn loans, restructuring your company to boost financial performance, being chased by HMRC, or even unable to take any money from your company due to a lack of profit…call us today 0800 970 0539