QUESTION: My wife and I are the only directors and shareholders of a trading company with a March 31 financial year end. Last year my accountant said that our directors’ accounts were ‘overdrawn’. What does this mean and how can we avoid it?
ANSWER: The company’s year end marks an important event for the financial relationship that exists between you and your company. The money inside the company belongs to it and not you personally. You are of course able to take as much money out of the company that is prudent to take however it must be taken in the proper form with supporting documents otherwise you are likely to end up with expensive tax bills.
Almost all small private company shareholding directors in the UK are remunerated via a combination of a small salary and a larger dividend. This is because dividends declared up to the level of the basic rate tax band are only taxed at 8.75% meaning that a family company controlled by a married couple can extract £100,000 annually at a very modest personal tax cost.
Furthermore, there is no national insurance charged on dividends which adds further savings for both the directors and the company. While this is a very favourable tax position, unfortunately shareholders too often become complacent and do not put the proper procedures and paperwork in place to ensure that these arrangements do not leave the company open to challenge by HMRC during for instance a PAYE inspection.
Business owners, ignorant of tax law or who couldn’t be bothered to pay for proper advice, often simply draw the same amount of money out monthly, post it to ‘wages’ within the company’s accounting system adding the description ‘dividend’.
Such behaviour makes a PAYE inspector’s job very easy to re-allocate all payments as wages and issue a demand for PAYE and national insurance on the grounds that the directors have extracted untaxed wages from the company and not a validly declared dividend.
It is therefore essential therefore that you ensure that any dividends are properly declared and posted to your company accounting system initially and are supported by company board minutes declaring the dividend (having checked that the company has the requisite reserves to declare the dividend) and dividend vouchers should be issued to the recipients to enable them to self-assess themselves to income tax on the dividend within their tax return.
This dividend will create a positive balance on your directors’ loan account (DCA) and thereafter, on usually a monthly basis, the dividend is drawn down and the balance of the DCA reduces. It is important that the DCA balance does not become negative or ‘overdrawn’ as this has both personal and company tax implications.
If you have an overdrawn DCA therefore, you have still time to validly declare a dividend and clear your indebtedness to the company.
But remember, the dividend itself is taxable so you will have to gross it up to cover the tax liability that will result next January.
Finally, if you want the company to contribute to your pension scheme, it must be paid before the company’s financial year end as tax relief is only available on contributions paid within the year.
- Paddy Harty (p.harty@fpmaab.com) is tax partner at FPM Accountants Ltd (www.fpmaab.com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies
