When taking money out of a limited company, it’s completely understandable that consultants or owner directors will want to do so in the most tax-efficient way possible. Dividends are simply a portion of the company’s profits which are returned to shareholders i.e. you the consultant, after corporation tax has been applied, and this is almost always the most tax efficient route you can take.
As of April 2016, the dividend tax rules are set to change. The result is that the vast majority of consultants will have to pay more tax; but despite this, dividends still remain the most efficient way to take money out of a business.
The process of taking a dividend is a relatively simple one, but there are still some potential stumbling blocks consultants need to be aware of. In this article, we’re going to take a look at a few of the problems that may crop up, and the solutions you can apply to keep your one-person limited company on the straight and narrow and well away from the suspicious eyes of HMRC.
1. Complete the relevant paperwork
Limited company owner managers must satisfy a number of different criteria when paying themselves a dividend. Consultants that fail to justify dividend declaration decisions or complete the relevant paperwork could find themselves in hot water and have their dividends declared ‘illegal’ by HMRC. Consultants found to have paid illegal dividends could have the payments reclassified as a salary and be forced to pay income tax and National Insurance contributions. If the dividend is not repaid, it may then be classified as a director’s loan.
2. Dividends can only be paid on profits
Dividends can only be paid from distributable profits as shown on the company’s balance sheet. If the company does not have a positive profit and loss balance, you, as a consultant, cannot legally pay yourself a dividend. If you do and the company becomes insolvent, the insolvency practitioner/liquidator will ask you to repay the money, because in effect, what you have actually done is created an overdrawn director’s loan account.
3. Dividends cannot be paid by insolvent companies
One of the primary responsibilities of administrators and liquidators in insolvencysituations is to investigate and report on the conduct of the company directors. One of the purposes of this investigation is to ascertain whether any payments have been made which could be recovered for the benefit of the company’s creditors. Consultants who pay themselves a dividend despite being insolvent could find themselves personally liable for a proportion of the company’s debts.
If money is taken from the insolvent company directors may have acted beyond their powers and taken ultra virus dividends more commonly called illicit or illegal dividends. Ultra Virus in this context means ‘acting beyond your authority’ and this money would be treated the same as money owed to the company and need to be repaid.
4. Paperwork cannot be completed retrospectively
Simply having ‘distributable profits’ is not enough to pay yourself a dividend; you must also fulfil all your documentary obligations at the time the payment is made. You cannot go back and complete the relevant paperwork after the company has entered insolvency as you will be asked for the money back. Insolvency practitioners often see cases where the paperwork doesn’t exist because the accountant intends to complete it when he files the annual accounts. If the company goes into insolvent liquidation or administration before the paperwork is prepared, you could be liable. Even if the company enters into rescue package such as a company voluntary arrangement the money will be expected to be repaid before a proposal will be accepted – especially if HMRC are involved.
5. Produce proper accounts
Accounts to show the company has sufficient distributable profits to pay a dividend must be drawn up properly in the shape of recent management accounts or the previous year’s filed accounts. A few simple calculations on a scrap of paper will not do.
6. Hold a meeting of the members
Once you have demonstrated the company has sufficient profits to pay the dividend, the next step is to hold a meeting of the company’s members to authorise the dividend and declare the payment. It might sound ridiculous to hold a one-person meeting, but this meeting should still be properly recorded to ensure the payment is legal.
How can we help?
If your one-person consultancy company has recently become insolvent with an overdrawn directors’ loan in place, please speak to our team immediately for help negotiating a mutually acceptable settlement. We negotiated over £1.4m HMRC vat, paye and corporation tax arrears settlements in the last quarter alone excluding company voluntary arrangements. Call 08000 746 757, email: [email protected], or use the live support feature on our website.