Running a business can be hard work. Maybe you work long hours and have little time for holidays. There’s the responsibility you feel for employees and potentially, financial worries about cash flow amid ongoing economic instability. But there are also upsides to being a business owner especially if you are a company director. One big one is the flexibility that running an incorporated business can offer when it comes to your own income.
If you are an SME limited company shareholder/ director, you will most likely receive your income from the company through a combination of salary and dividends.
It is also however not uncommon for director/shareholders to ‘borrow’ money from their company, i.e. to simply ‘take’ funds that have not been voted as a dividend or do not represent net salary. Such borrowings will be allocated to a director’s loan account and it is later necessary to repay the overdrawn amount. Repayment will usually be made in the form of dividends that are voted but, rather than being paid to the individual, are credited to their overdrawn loan account to repay the borrowings. If the company does not have sufficient retained profits to vote the necessary dividend, then unless the individual can repay the overdrawn amount personally, the company will often pay a bonus with the net bonus being used to repay the loan.
The individual will need to pay interest on the overdrawn loan amount, or will be chargeable to an income tax ‘benefit in kind’ charge on interest not paid.
If a director’s loan account remains overdrawn nine months after the company’s accounting year end, a tax charge of 33.75% is payable by the company on the amount overdrawn. This is known as a section 455 charge and does of course negatively impact the company’s finances. This tax is repayable to the company nine months after the accounting year end in which the loan account is brought back into credit.
The necessity to vote dividends which are used to repay borrowings rather than being paid to the shareholder also give rise to personal tax liabilities, which often come as a shock to the individuals involved, especially when income tax payments on account for the following tax year become due at the same time.
To avoid such unnecessary tax shocks, it is always advisable to have a dividend/ salary policy that you follow, and to take advice before withdrawing additional funds.
What can you do if you already have an outstanding director’s loan to repay? Firstly, there is the option to repay the amount borrowed before the nine-month year end deadline. This is the simplest solution and means the company will avoid the section 455 charge. If the company has sufficient distributable reserves, a dividend can be voted to repay the overdrawn amount.
If the company does not have sufficient distributable reserves, the overdrawn loan can be written off. If this route is chosen, the company will no longer expect repayment from the shareholder, but the amount written off will be treated as a distribution, and charged to income tax on the individual in the same way as if they had taken a dividend.
RJP specialises in supporting owner managed business owners with tax compliance and planning services, if you would like to discuss any aspects of tax strategy, please get in touch via partners@rjp.co.uk.