As a director of a limited company, you should be remunerated accordingly for the work you do. You’ve taken the brave step to set up your own business and live without the security that comes with working as an employee, so, if things are going well, this extra risk should bring reward. In this article, we’ll take a look at the different ways a director can take money out of a limited company, and examine the risks associated with taking a dividend.
Three ways directors can take money out of a limited company
(1) Salary, expenses and benefits – If you want the company to pay you a salary, expenses or benefits, you must register the company as an employer with HMRC. You must pay Income Tax and National Insurance contributions on any salary you receive, and pay the National Insurance contributions of your employees.
If you then make personal use of an asset that belongs to the business, you must report that as a benefit and pay any subsequent tax due.
(2) Directors’ loans – If you take more money out of the company than you have personally put in, you will be taking what is known as a ‘directors’ loan’. This is not a salary or a dividend, but is effectively a loan made to you by the company. If you take a directors’ loan, it’s essential you keep accurate records as they are subject to their own set of tax rules.
(3) Dividends – A dividend is a payment a company can make to its shareholders if it has made a profit. The company cannot pay more in dividends than the profit it has made for the current of previous years. Dividends are not included as business costs when calculating your Corporation Tax payments, and must usually be paid to all shareholders.
To pay a dividend you must hold a directors’ meeting to ‘declare’ the dividend, and keep minutes of that meeting even if you are the company’s only director. You must also draw up a dividend voucher for every dividend payment the company makes.
The risks associated with taking a dividend
One of the attractions of forming a limited company is the reduced level of tax to pay on dividends. Many directors choose to take a minimum salary (up to National Insurance limits) and draw the rest of their pay as dividends. However, this strategy is not without is not without its risks.
1. Paying yourself a salary increases the level of contributions that can be paid into a personal pension. If you want to receive a dividend and make a pension contribution, you should consider setting up a company pension scheme.
2. Whilst salaries can be allocated to directors at different rates, shareholders are entitled to a dividend at a fixed rate per share. However, if there are non-working shareholders in the company, it is possible to create different classes of share to prevent them receiving the same dividend rate as directors working fulltime.
3. Dividends can only be paid on profits made by a company that year, or undistributed profits from previous years. However, salaries can be paid even when a company is making a loss.
4. Although PAYE does not have to be paid on dividends, there are a number of procedures that must be followed for the dividend payment to be lawful.
5. Paying a salary can reduce the company’s corporation tax bill; paying a dividend will not.
What if the company is struggling?
Paying a dividend is all well and good if the company is doing well and making a profit, but if it starts to struggle becoming insolvent and you still take a dividend payment, you could end up with a substantial overdrawn director’s loan account at the end of the year. This is money you have taken out of the company that must be paid back. The result could be that the only money you earn all year is the minimal salary you have paid yourself.
Any director’s loan account you accrue is taxable at 20 percent if it is not repaid within nine months of the end of the Corporation Tax accounting period. If the company then fails and enters into some form of company insolvency, such as compulsory Liquidation (Winding up) an administration, company liquidation or company voluntary arrangement (CVA), you will have to repay this money for the benefit of the company’ creditors.
If you are worried about the financial position of your company, or your business has become insolvent with a director’s loan account outstanding, please contact the turnaround practitioners at Jameson, Smith & Co. immediately. Any initial advice we offer is free and without obligation, so please call 08000 746 757 or click here to arrange an initial consultation.
Written by: Mike Smith