Most people who form a limited company understand that it is a separate legal entity, many however, especially those who previously traded in an unincorporated form, do not fully appreciate what this means in respect of taking money out of the company.
In a sole trader situation the proprietor is free to withdraw money from the business as he/she wishes, however this is not the case with a company.
Where a director withdraws funds from a company in excess of their remuneration (normally salary and/or dividends) these withdrawals are set against any balance owing to the director (perhaps money loaned to the company to cover start up costs, or undrawn dividends, for example).
Where there is an insufficient balance available to cover these withdrawals, this creates an overdrawn loan account situation, and potentially two tax issues:
- S455 tax
Where a close company Director’s Loan Account remains overdrawn at the year end, and the balance is not repaid to the company within nine months, the company will be subjected to tax at 32.5% on the amount outstanding.
This tax is repayable once the loan has been cleared, however repayment is not always quick. The due date for repayment is nine months and one day after the end of the year in which the loan was repaid. Dependant on the timing of the loan repayment, this could mean a delay of around twenty one months before the tax is due for repayment.
- Benefit in kind
Where an overdrawn loan account exists, unless the director is charged interest or the loan is provided for a qualifying purpose, if the loan exceeds £10,000 at any point during a tax year, the company must report the value of the ‘benefit ‘, calculated as defined by HM Revenue & customs, on a P11D form.
The company will be charged Class 1a National Insurance at 13.8%, and the director will suffer tax between 20% and 45% (dependant on their tax band) on the value of the benefit.
One final point to note is that overdrawn Director’s Loan Accounts must be disclosed in the company’s accounts that are filed at Companies House, and the details are therefore available for public viewing.
With planning the above pitfalls can often be avoided.