Insights

Running your own limited company comes with a number of freedoms. One of the most tempting is the opportunity to access company money and withdraw funds for personal use. Many small company shareholders will simply take what they require, allocating their drawings to personal expenses and cash withdrawals, with these subsequently being allocated to their director’s loan account.

This article outlines some key things to be aware of when withdrawing company funds, to avoid either incurring additional taxes, or falling foul of HMRC.

Provided records are maintained properly and company funds allow, there is nothing wrong with shareholders withdrawing money from their company, providing the company has sufficient reserves available. These drawings should be treated as a dividend at the time of payment, and the necessary supporting paperwork prepared. However, this sometimes doesn’t happen, and the director’s loan account becomes overdrawn as a result. The overdrawn balance is effectively a loan to the director, which is usually ‘cleared’ by voting a dividend which is credited to the loan account, often following the end of the company’s financial year when the accounts are prepared.

In this case, the following is should be borne in mind:

• Where a shareholder has an overdrawn loan account (a loan from the company) for a period of time, interest should be paid on that loan, at HMRC’s official rate of interest. If interest isn’t paid to the company, income tax is payable by the individual on the interest that should have been paid;
• If a loan is not repaid within 9 months of the company’s accounting year end, the company will have a tax charge under the ‘loans to participators’ legislation, at the rate of 32.5% of the amount of the overdrawn loan. This is repayable 9 months after the accounting year-end in which the loan is repaid.

Despite recent increases to tax on dividends, they tend to remain the most tax efficient way for shareholders to extract profits from a company and are the preferential route for the vast majority of small company shareholders. However, there are other issues that need to be remembered:

• As touched on above, a company is only able to vote dividends provided it has sufficient distributable reserves (accumulated profits) available. If this is not the case, the company risks being in breach of the Companies Act;
• The available reserves must be sufficient to cover the appropriate rate of dividend being paid to every shareholder;
• The rate of dividend must be voted in the appropriate ratio to each shareholder, according to the number of shares they hold. For example, if a company has two shareholders with equal holdings, the dividends paid out should also be equal. It is possible for shareholders to waive their entitlement to dividends, provided certain procedures are followed, however the above points still apply.

Once a dividend is voted, even where it is not paid to the individual because it is being used to cover their director’s overdrawn loan account, it must be included on the individual’s self assessment for the appropriate tax year, and income tax paid.

The current rates of dividend tax are:

Tax band                              Tax rate on dividends over £5,000

Basic rate                                7.5%

Higher rate                             32.5%

Additional rate                       38.1%

From April 2018, the tax-free dividend allowance will reduce to £2,000, after which payments will attract the basic or higher rates of tax.

Under self assessment you are also required to make payments on account of your tax liability for the following year. Therefore, when you are receiving large dividends it is helpful to make this calculation as soon as possible to prevent unexpectedly large liabilities arising.

If you are a small company shareholder and would like to discuss tax efficient remuneration strategies with us, please contact Lesley Stalker by emailing partners@rjp.co.uk