Summary

It is your company so you can spend the profits as you like? Well no, it’s actually the company’s money which is a different legal identity so tax will be charged in one form or another.
In this episode we will cover the different options available for taking money out of your company and the implications of each option.

 

Natasha 00:37

Hello, and welcome to episode four of Tax Able with Natasha Heron. Today’s episode is It’s my money I’ll spend if I want to. We are exclusively talking about companies today. If you are self employed or part of a partnership, this may not be relevant to you. However, if you are thinking of incorporating, please stay and listen.

 

Natasha  00:59

But what do I mean about incorporating? This is where you turn your sole trade or your partnership business into a formal company format. A company is legally separate from its owners and its owners are called shareholders. The day to day running occurs by the managers, but the managers are called directors. The shareholders and directors may be the same people, but they have very different rules surrounding them in very different roles.

 

Natasha 01:25

A company is incorporated, a company’s house, and it’s governed by the requirements of the Company’s Act and its own articles of Association. It must submit accounts to Companies house, and the information is publicly available on a register. So why would someone choose a company rather than a sole trader or a partnership?

 

Natasha 01:48

Well, it’s all to do with protection and protection is key. A sole trader or a general partnership are unincorporated businesses, and this means that there’s no legal distinction between the owner and the business.

So if the business fails or a claim is raised against the business and it cannot meet its liability, the owners would be personally responsible, and this means that debt collectors can come after your own assets, such as your house. This is why a lot of people choose to incorporate a company because the owners, the shareholders and the business are legally separate.

 

Natasha 02:29

This is the case if only one person is involved. For example, if there’s only one shareholder and that person is also a director, they are still legally separate from the business. If the business fails, the debt collectors cannot go after the shareholder for any personal assets.

 

Natasha 02:47

So it’s your business. You’re the shareholder and you’re the director or either and you’re running it. You’ve made some money so you should be able to do what you want with that money, right? Well, no, this is the problem and the biggest misunderstanding that I find with my clients and mainly with my friends, that they do not understand that they are legally separate from the company. It’s the company’s money. The company has its own bank account in the company’s name, not in the individual’s name, because you’ve opted for the protection. If the company fails, it’s the company’s money the company’s assets.

 

Natasha 03:24

So if you want to take some of the company’s money, you’re going to end up paying tax in one way or another. But there are different options available to you for how you extract or withdraw the money from the company.  We’re going to go through five different options.

 

Natasha 03:41

If you just transfer yourself some money without any documentation or reasoning, it will get classed as a director’s loan account. Emphasis on the loan. If you’re not a director, it may be treated as a participator loan. But for ease, we’re just going to call it the director’s loan account.

 

Natasha 03:59

Because it’s a loan funnily enough, you’re expected to pay it back. You wouldn’t believe the amount of times you talk to people and explain that they have a loan account and they don’t understand that they have to repay the loan.

 

Natasha 04:13

If the loan is not repaid within nine months and one day of the year end, the company has to pay what’s known as a section 455 charge, and this is at a rate of 32.5%. It forms part of the company’s Corporation Tax return.

 

Natasha 04:35

Why do they charge a S.455 charge? What’s the reasoning and understanding behind it?It’s to put you on the same footing as you taking a dividend, and that’s why the rate is the same. But in this scenario the company pays the s.455 charge, not the individual. Once the loan is repaid, the company is refunded to s.455 charge.

 

Natasha 04:57

Second option, you’ve got take a salary. To do this, you’ll need to go on the payroll. You can either be on an annual salary or a monthly salary. It’s completely up to you. You will be taxed as any other normal employee you would be.

 

Natasha 05:12

Income tax rates currently are 20%, 40% and 45%, respectively, and National Insurance is charged,the company will pay employer national insurance. Please do remember, though, if you do decide to take a large salary and by this I mean over £100,000 a year, there is an adjustment that’s required to your personal allowance.

 

Natasha 05:38

Now the third option available to you is to take a dividend. You can only take a dividend if you’re a shareholder of a company, and that’s because you have a right to the profits of a company. Dividends are taken out of reserves and by reserves and by this I mean accumulated profits. In order for a payment to be classed as a dividend, there needs to be a piece of paper called a dividend voucher and that is completed and usually it’s backed up by a board minute. You can prepare these documents yourself, but considering the amount of conditions associated with a dividend it is recommended that you have accountant or tax adviser prepare these documents on your behalf.

 

Natasha 06:20

There is a sweet spot where you take a low salary and take the balance of dividends. But you need to look at whether the company is generating sufficient profits for this to occur. That is the point where everyone wants to get to as It’s the most tax efficient ways. But just because it’s the most tax efficient doesn’t mean it’s feasible. If you do not check your reserves regularly, you could fall into a situation where an illegal dividend is taken and this is as bad as it sounds.

 

Natasha 06:47

It’s not illegal where HMRC is going to turn up and put you in cuffs, but it will cause you a headache. An illegal dividend is one where the amount taken in dividends exceeds the amount of accumulated profits. You will be in what we call negative equity. HMRC do not like this, as you can imagine, and they will more than likely raise an enquiry into the company.

 

Natasha 07:10

So how do you avoid this? Make sure you are constantly checking your reserves. You can check with your reserves with your advisor. You should maybe have management accounts. It depends what accounting software you use but please make sure you check your reserves before you take a dividend. The dividend rates are lower than income tax and you have £2,000 tax free, 7.5%, 32.5% and 38.1%, respectively. I haven’t gone through to the different thresholds because I’ve assumed you have a general understanding of how much you can take out of what level. If you do not know the thresholds, please get in contact with me, but you can find all the information on the Gov.uk website.

 

Natasha 07:52

The fourth option is to take a pension contribution. No Corporation Tax arises on these payments. National Insurance is not triggered, but it’s not ideal if you’re quite young. Those under 55, you need an accessible source of income for your living expenses. If you are approaching pension age, great, you can make a large contribution to a pension because you’re closer to the age to be able to draw it down.

 

Natasha 08:16

The fifth and final option is to leave the profit in the company and take the proceeds when you sell. This is fine if you don’t need the day to day money and you have income from other sources or if you’re looking to sell in the short term. Perhaps you’re in an industry such as technology where companies are around for a couple of years and then they’re sold. But you need to assess what works for you.

 

Natasha 08:39

No one likes making tax payments, but if you can do it in a tax efficient way that gives you the best outcome and the most money in your pocket when you need it and that is key or when you need it. Because cash flow is key, you need to make sure that you have enough to pay your living expenses and to be able to enjoy the proceeds of your business.

 

Natasha 09:02

The company has sufficient reserves and you aren’t ready to take a pension. So let’s look again at that sweet spot, tax efficient option of taking a small salary and the balance of dividends. The salary you take will be below your personal allowance, so no Income Tax is triggered. It also will not trigger employee or employer National Insurance, but you’re being paid enough to not lose the benefits associated with National Insurance for 2021.

 

Natasha 09:33

The tax optimal salary for from 2020/21 onward is above £8,788 per annum and then you take the balance of dividends. If you wanted to pay yourself, for example, £100,000 a year, you would then split this as £8,788 salary and the balance as dividends. Make sure the dividend vouchers are prepared.

 

Natasha 09:58

The final point I’d like to raise is to make sure that you are always claiming for any  expenses you pay on behalf of the business. A lot of people forget to submit expense claims for their own companies. This is because they feel like the company’s money is theirs and vice versa. But remember, they’re separate legal entity. So as a director, if you take a client out on a business meeting that’s client entertaining, you pay for that on your personal card. The company can refund you the money the same as for any subsistence and subsistence means if you’re out for a business purpose and you buy yourself a coffee or you go for lunch just by yourself. No clients involved, then you can claim the cost of that coffee or that lunch Other items are mileage for business trips at the HMRC approved rates (£0.45 for the first 10,000 miles and £0.25  thereafter. There is no tax on these payments. The expenses are repaid in full.

 

Natasha 11:02

If you have any questions about the topic in this episode, or if you have a query regarding your own situation or you simply would like to chat with me, please contact me using email address help@taxable.uk.

 

Natasha 11:48

Thank you all for logging in and listening. I hope you have the best Christmas Day. 2021 was much better than 2020 and you’re looking forward to the New year. Hopefully Coronavirus will be a thing of the past and we can all continue moving forward. I hope you’ve started your week off well by learning about a new topic and please do let me know if you have any questions, but I wish you all the best and a happy New Year and I’ll speak to you in 2022. Thank you.

 

*This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Please visit my disclaimers page for more information. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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