In these tough times, many small company owners will look to withdraw money from their business to fill the funding gap. Mahin Khawaja from Clear Books partner Adroit Accountax takes an overview of some of the legal and tax implications of the different options.
There are four main ways to take money out of a company:-
• Reimbursement of Expenses
• Director’s Loan
Directors (with no other income) are entitled to earn up to £7,488 in the year to 31 March 2013 without incurring national insurance. Earnings above this limit will result in an employer’s NI payable by the company, and employee NI payable by the director personally. Income tax is chargeable on earnings exceeding £8,105.
Paying directors a salary helps reduce a company’s corporation tax bill.
There is no doubt that the most tax efficient way to withdraw money from the company is in the form of a low salary and then expenses and dividends. Keeping the salary low saves national insurance – how low should be a point of discussion between you and your accountant.
Reimbursement of Expenses
For small business – especially for single person businesses – this could be important factor. Expenses that could be reclaimed include the mobile phone bill, client entertainment, travelling costs, staff entertainment and use of home as an office.
Each £1 of expense saves 20p of corporation tax and helps to withdraw money from business account.
Do take advice on whether a reimbursed expense constitutes a taxable benefit or is subject to National Insurance – this can be a complex topic.
Tax on dividend income tends to be lower than for other types of income, and also benefit from an effective notional tax credit of 10%. Thus, basic rate tax payers end up paying no tax at all on dividend income received. For higher rate (but not advanced rate) tax payers the effective rate is 25% of the net dividend, compared to the 40% tax rate on salary. No National Insurance on dividends is payable by either the company or the director.
The downsides are that dividends don’t count as a business cost, so don’t reduce the corporation tax payable by a company. Also, it is illegal to pay dividends from a company unless there are retained earnings available in the company for this purpose. This should include a provision for tax due on profits earned, depreciation of assets, and for services and goods invoiced but not yet delivered.
Director’s Loan Accounts
Many directors have a loan account with their company. Repaying monies owed by the company to its directors does not result in a tax charge on the director or the company (but doesn’t utilise the director’s tax free personal allowance).
Where the director owes money to the company there are important tax implications: –
• For all loans, including loans to a close relative, a “Section 455” tax charge of 25% of the amount owed is payable. This amount is repaid by HMRC as the loan is repaid
• For loans in excess of £5,000 a taxable benefit in kind is received which needs to be reported in a form P11D. Employer national insurance is payable, and the benefit is taxable income chargeable to the director.
• For loans in excess of £10,000 a shareholder resolution is required by law
There are a few exclusion to the rules. Some types of qualifying loan will not attract a benefit in kind charge. A company can pay £1,000 of advances in anticipation of expenses to directors or employees without attracting the 25% charge.
A clever tax tip may be to meet short term personal funding requirements for less than £5,000 is to take out a loan from the company, then repaying this with dividends within 9 months of the accounting year end when profits become available for this purpose.
Anti-Avoidance and HMRC
At a recent tax case PA Holdings (2011) the payment of bonuses disguised by a complex scheme as dividends to employees was held to be ineffective for tax purposes. The case is being appealed, and it is expected it will go to the Supreme Court. HMRC had created an anti-avoidance rule in response to this and similar cases, taxing as employment income dividends paid
“where something has been done which affects the employment-related securities as part of a scheme or arrangement the main purpose (or one of the main purposes) of which is the avoidance of tax or National Insurance contributions”
This case has made a lot of owner managed business consider whether very low salaries and high dividends can be caught by anti-avoidance legislation, causing the dividends to be taxed as employment income. HMRC, however, have indicated they will not construe legislation in this way.
So what is best for me?
As long as you have a proper business structure and company pays dividend out of the profit of the business and there is no contrived scheme to avoid income tax or NIC on remuneration or to avoid the IR35 rules, HMRC will not seek to argue the anti-avoidance scheme apply.
The optimal balance between salary, dividends, expenses and director’s loan is an impossible question to answer without a detailed knowledge of your circumstances. My advice is very clear – if in doubt – ask an accountant. Tax law is notoriously detailed and complicated, with both opportunities and pitfalls that are difficult to anticipate.
Mahin Khawaja (ACCA) is the tax director at Adroit Accountax Ltd. His contact details are available from his directory listing available here. The opinions stated in this article are those of the guest blogger – Clear Books does not give tax advice.