If you are a sole trader or a partnership, the money in your business bank account belongs to you. Of course, you still have people that you owe money to – like HMRC and your suppliers, who will expect you to pay them first. If you’re in a partnership, you might want to square it away with your partner too as it doesn’t tend to go down very well if they find the cupboard unexpectedly bare.
This is because there is no legal separation between you and your business. You have unlimited, personal liability for the business’s debts and its duties of care. If you weren’t aware of this, it is time to think carefully about whether you have enough insurance in place. You might also want to think about incorporating (becoming a company). It is also essential to understand that you are taxed on the basis of your business profits, NOT the cash in the bank. It makes no odds whether your customer has paid you or whether you have paid your suppliers – your accounts should be prepared on an accruals (rather than a cash) basis, meaning that income and expenditure must be matched according to time and trading activity.
If you trade via a limited company, then none of this applies to you. Any money in the bank belongs to the company. It is NOT yours. You have absolutely no right to just help yourself when your personal account is running a bit low. There are only 4 ways that you can take money out of the company bank account without applying for a fast-pass to HM Prison Ford.
The 4 ways to extract funds from a limited company are:
- Reimbursement of expenses
Salary must be processed via a PAYE payroll scheme and reported to HMRC in accordance with the Real Time Information rules. The company then pays over your income tax and National Insurance directly to HMRC on your behalf. You can choose the frequency of your payroll but you must submit a Full Payment Submission to HMRC on or before the date that the funds are paid out to the employee (even if you own the company).
If you pay for a business expense from personal funds like a credit card, or claim mileage for business expenses, you can reclaim that money from the company and there are no tax consequences for either party. The company can even claim the VAT back subject to the normal rules such as having a valid VAT receipt. Please note the important word in the first sentence – business. You can’t bung a private expense through the business.
If you are also a shareholder, you can also withdraw dividends as a reward for your investment. Broadly, the rule is that you must have sufficient distributable reserves to declare 100% of the dividend, even if a shareholder waives their right. There is a process that must be followed to make a dividend “legal” meaning that it complies with Companies Act and satisfies HMRC’s criteria. This includes calculating distributable reserves and preparing the appropriate company secretarial documents e.g. a board minute. Ensuring that you follow the correct process is important because you wouldn’t want anyone to question whether a dividend should actually treated as employment income or a loan – neither of those options are appealing alternatives from a tax perspective.
Finally, and importantly, we come to loans. Due to the potential abuse of loans as a way of taking money out of a business without paying any tax, there are significant anti-avoidance provisions. There is specific legislation for loans that go over £10,000 at any point in the year and where a loan of any value remains outstanding 9 months after the company’s year-end. If your loan exceeds £10,000 at any point, you will either have to pay the company interest at a market rate or pay income tax because a tax-free loan constitutes a benefit-in-kind. The loan also needs to be documented officially by the company. If there is a loan outstanding 9 months after the company’s year-end, the company will be liable for a 32.5% penalty tax commonly known as “section 455” (due to its number in the Corporation Tax Act 2010). The company can recover this penalty tax but only when it files its next corporation tax return meaning that these funds are locked away for at least 12 months.
A loan is not just where you withdraw cash out of a bank account. If the company settles a personal debt or pays for a personal expense e.g. mortgage payment, this is also a loan.
Experience has shown us two major learning points for our clients. Firstly, this is a major adjustment for sole traders/partners when they move to trading as a limited company; it requires discipline and planning so this is an area where we provide support and advice. It also means that some people are just not well-suited to life as a limited company and should stay as they are – nothing wrong with this, horses for courses and all that. Secondly, without careful monitoring, the rules can trip up a lot of companies and leave them with a sizeable and unexpected tax bill. But it doesn’t have to be this way. We help clients by creating a tailored, extraction policy to pay down the loan before the penalty arises.
If you would like advice on any of the points covered, please contact us for a confidential conversation.