Operating through a limited company can be a tricky business, as this month's Tax Clinic query indicates.
 Mark McLaughlin
For some small business owners who operate through a limited company, it can be difficult to understand (or accept!) the concept that the income they have helped to generate belongs to the company and not to them, and that extracting funds from the company has potential tax consequences. There are company law issues to consider as well. For example, has the dividend been properly authorised? In addition, dividends cannot generally be paid unless the company has sufficient distributable reserves available. It is often tax-efficient for private, family companies to pay dividends as opposed to a salary or bonus. However, care is needed to ensure that the dividends are lawful and properly documented. It is not really sufficient to withdraw funds from a company and simply attach a 'dividend' label to it. Is the dividend 'interim' or 'final'? For owner managed businesses in particular, problems can arise when dividends are paid during an accounting period. When accounts are subsequently prepared for that period, it may transpire that the company had insufficient reserves to cover the dividend. It then becomes necessary to consider the tax implications of those payments. This is the theme of the following query, from 'dmkg'. Query from TaxationWeb visitor ('dmkg')I have drawn 'dividends' from my company in anticipation of profits but it now turns out that the company actually made a loss for the year which ends in a few days. Unfortunately, I am unable to pay this back to the company and as the company can't pay dividends without profits (none in reserves either) all the money drawn will have to be charged to my loan account which is now overdrawn. What are the tax implications of a director's loan account being overdrawn? Editor’s CommentsThere is useful guidance on HMRC's view of unlawful dividends and their tax implications in their 'Company Taxation Manual'. In particular, paragraph CTM20095 discusses company law aspects of dividends (http://www.hmrc.gov.uk/manuals/ctmanual/CTM20095.htm). The tax treatment broadly depends in part on whether the recipient shareholder knew, or had reasonable grounds for knowing, that the dividend was unlawful. In the case of owner-managed companies, HMRC may well conclude that the shareholder knew, or should have known, that the dividend was unlawful. Their guidance (at CTM 20090) presently states the following in cases where the unlawful dividend is retained, as opposed to being repaid to the company (see http://www.hmrc.gov.uk/manuals/ctmanual/CTM20090.htm): 'You may find that a close company has paid an ultra vires dividend in cash and, despite knowing or having reasonable grounds to believe that the dividend was unlawful; the shareholder has chosen to retain the benefit of the money. In this case you could argue that the company has made a loan to the shareholder by virtue of ICTA88/S419 (2) thereby triggering a charge under ICTA88/S419 (1).'
In broad terms, a 'close' company could perhaps be interpreted for these purposes as a 'closely controlled' company, so family and owner-managed businesses in particular should take note of the above guidance. The legislation mentioned concerns a tax charge on the company. However, if the unlawful dividend is treated as a loan, there are potential personal tax implications for the director, as well as National Insurance implications for the company. 'dmkg' does not apparently use the services of an accountant. However, business owners generally, and in the situation outlined in this query particularly, are advised to seek their own expert professional advice. Forum responses included those reproduced below.'davidbarry' commented:Interest becomes chargeable on overdrawn loan account at a commercial rate of interest subject to your contract with the company.
However, if dividends are properly declared then these are dividends-however, your company bank account would be overdrawn-so why were they voted? More investigastion is needed. 'dmkg' replied:I draw a fixed amount each week and then a dividend is put through the books to cover these drawings. But as there is no profit a dividend can't be voted thus creating a debit balance on my loan account. Does this mean that if I pay interest on the money borrowed then there will be no further tax liability? 'King_Maker' commented: The relevant payments can only be wages or loans. Both can have adverse tax implications. Have you consulted your accountant on the matter? 'dmkg' replied:I don't have an accountant at present. I am the sole director and majority shareholder in the company. I assume I'd have to pay corporation tax on the debit balance on my loan account or interest to the company? 'wamstax' commented:You seem to be trying to do things on the cheap when you could have potentially avoided this situation by engaging some professional with the appropriate expertise. Correct this situation or you may end up jeopordising your company's wellbeing for the future. 'dmkg' replied:Thank you for suggesting that I get an accountant. I did speak to one about this but, just as the comments posted here, I did not get an answer to what the tax consequences of a director having an overdrawn loan account would be. I've been told the company will have to pay 25% advance corporation tax on the loan balance which will be refunded when the loan is repaid. Someone else has suggested I'd have to pay interest to the company. Maybe I'd be liable to both? 'okevin' commented:you are correct, the company would need to pay section 419 tax at 25% on the balance. The company will get this back when loan is repaid. You would also need to pay personal tax on the benefit in kind. The company would also pay class 1a nic on this benefit. Can you accrue a bonus (which may be beneficaial if you are not a higher rate tax payer) which will need to be processed through payroll within nine months of your accounting period ending. -------------------------------------------------------------------------------- To view this discussion online (including any possible updates), go to:
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