Congratulations, you have set up a limited company. This professional structure is going to add a lot of value to your brand – see the advantages of becoming a PLC. It’s your company, so surely dipping into the company profits is fine? You have worked your derriere off to make those profits.
Unfortunately, the ‘what’s in my personal account is mine and what’s in the business account too’ is a big mistake that is often made by business owners transitioning from a sole trader setup. A limited company is a separate legal entity, and, in the eyes of HMRC, you cannot dip into someone else’s income and treat it as yours. Any monies accrued to the company in the course of doing business belong to the business, regardless of the fact that you, personally, worked to generate that profit. It is not your personal bank account.
When your limited was incorporated at Companies House, all the company’s assets and profits, present and future, belong to the company. You, as the business owner, are an executive director or employee. Just as another employee cannot remove company funds, nor can you. Your legal liability is separated from the company; hence the company money must address its risks first. As a sole trader, your legal liability is merged with the business, and the funds automatically cover the business and you.
Removing funds from a limited company account
In order to take money out of a limited company legally, you have to choose one of three methods. With all three of the permitted ways, there is supporting accounting and strict record-keeping requirements to make the tracing of funds easy. Another very important point to remember is that when you are dipping into the funds in the company accounts, even if you are recording it correctly, you may not remove money out of the company account if it is not in profit. This is not allowed because those funds are ‘spoken for’ or allocated to tax or a creditor. To legally access those funds, you would need to get permission from the creditor to whom the funds theoretically belong. You are not acting in the best interest of the business but removing non-profit funds; therefore, you are failing in your duties as a director.
The correct processes to follow in order to be allowed to take money out of a limited company bank account, in compliance with the law, are as follows:
You can pay yourself a director’s salary. Some set their salary amount above the Lower Earnings Limit to obtain the benefits of qualifying for the state pension but also cap the maximum amount to keep it but to keep it below the National Insurance Thresholds, so they don’t have to pay either employee or employer’s NI. Note: there are NI secondary thresholds that are lower, so consult with your HR or tax professional.
You can issue dividend payments from money that is on the books as an available profit.
You can record a directors’ loan. If there are shareholders in the business, you might have to obtain their permission first. Consult with your accountant on the parameters of your scenario.
You may claim for the reimbursement expenses that you have funded personally. These expenses must be for business-related items and must be justifiable with traceable records that will withstand an audit.
Should you access the money in the limited company?
Before diving straight into how to extract money out of the company, it is prudent to first ask whether it is in the best interest of the company for you to remove the funds? Many a director and accountant have bumped heads on this topic as accountants have deeper insights into the financial needs of a company’s risk profile and are acutely aware of how much cash needs to be set aside as a buffer. Unfortunately, to a majority of directors, those ‘piles’ of cash are expendable profits, and they are often depleted, leaving grossly insufficient reserves to protect the company when things go wrong.
This last phrase is an important one with such a subtle yet crucial word in it. It does not say ‘if things go wrong’. It says ‘when things go wrong’. As businesses involve human beings, contractors, suppliers, utility suppliers, weather, force majeure and many factors that are out of your control, it would be foolhardy to believe that nothing can go wrong. There is always something with the potential to go wrong. It is just the time and exact nature of the event that you do not know.
Your accountant will have done risk assessments and will have offset cash buffers against the risk; for example, bad debt might have 1.75% of turnover allocated to it in cash form. As a general and very rough guideline, some companies take a general 10% amount, calculated against gross sales, and reserve it as a buffer cash account.
This is not the only amount that should be set aside. There should also be allocations every month for taxes instead of scrambling at the end of the year to scrape together a large lump sum for tax. If you are scrambling to gather funds for your tax bill, this means you have spent or extracted non-profit tax funds during the year.
Three ways you can take money out of a limited company
Now that you have checked that all your buffers and allocations are in place, you can consider calculating (or needing) bonuses and dividends. It is advisable to only do this on a quarterly basis, not monthly.
Moving onto the withdrawing of money via a director’s salary, a payout of dividends or a director’s loan.
It is advantageous to get advice from your accountant and a tax consultant on the correct mix of these three methodologies. If you get the combination of these methods right, you will find yourself receiving an extremely tax-efficient payout. This payout will have minimised personal tax liabilities and, therefore, fewer funds will need to be removed from the business. Win-win.
This efficiency is achieved because corporation tax rates are currently at twenty per cent and personal income tax rates are at forty per cent for personal earnings that are over £50,001 – including the personal allowance of £12,500.
Let us look at the director salary option.
The director’s salary option
Obviously, the most commonly used option for accessing funds ‘stuck’ in a limited company is via directors paying themselves using the salary option. Company executive directors are employees of the business, but non-executive directors are not employees. Company executive directors will need to be registered with HMRC for PAYE, and they will also have to pay National Insurance Contributions on their earnings if the related thresholds are crossed, as mentioned above.
Across the board, it is generally observed that the majority of company directors have chosen to set their salaries at a very low level of £8,060, which is at the National Insurance Contributions threshold. They choose to then access additional money in the company via large sums paid out as dividends.
As mentioned above, by setting the payouts of salaries at this particular level, the director will still qualify for a state pension and benefits but does not attract the liability of personal tax.
Dividends are a hotly debated topic, and the accounting profession is not a fan of the way the majority of one-man limited companies issue dividends quickly at the end of each month. Paying off dividends in of itself is not the problem. The problem is that there is a blatant ignoring of the need to set aside corporation taxes, VAT savings and PAYE savings. This commentary might be irking some directors, but good financial processes require taxes and financial commitments to be set aside first before paying out dividends monthly.
The dividend payout option
This is hands down the best way to achieve tax efficiency when accessing funds ‘stuck’ in a limited company. However, on the topic of tax, if taxes cannot be paid at tax payment deadlines, then your company is not a going concern, or it is possibly insolvent.
In that case, dividends should not have been taken out, and the actions of the director are systematically building up a negative balance and utilising the funds of creditors. This could lead to the company’s ability to repay such debt to defaulted creditors, only being feasible if the company is liquidated insolvently. Once a company has reached this point, and it can be reached quickly with monthly dividends being paid, no amount of bemoaning their fate will save the dividend-overzealous directors from this unfortunate outcome.
If you are a well-behaved director and wish to keep your company strong and long-living, then you will have your taxes paid and cash buffers set aside. This healthy financial situation makes dividend payments feasible, and when the dividends are paid out quarterly, they will be from funds that already serviced the appropriate corporate tax liability.