Director's Loan repayment
Discussion
My business partner and I invested from our personal savings into our Ltd company (we are the only Directors). We have just completed our third year of just profitable trading and have for the last year been repaying ourselves a regular monthly amount from the Director's Loan Account together with a minimum salary.
I understand it is quite acceptable for us to also charge the company interest on the monies loaned but am not sure the best way to set this up particlarly re. the tax implications for the company and ourselves personally. Or is it better to pay ourselves a small dividend instead of interest?
Thanks for any advice.
I understand it is quite acceptable for us to also charge the company interest on the monies loaned but am not sure the best way to set this up particlarly re. the tax implications for the company and ourselves personally. Or is it better to pay ourselves a small dividend instead of interest?
Thanks for any advice.
There is nothing wrong with the company paying interest to you over and above the basic loan repayment amounts. However (as alway) there is a set of regulations you must comply with in order not to fall foul of the tax authorities.
Like any organisation paying interest to an investor, the company is obliged to deduct tax at source on the interest payments. This tax is called Composite Rate Tax and is charged at a 20% flat rate on the Gross tax inclusive interest amount paid (the equivalent of 25% of the net amount paid into the directors' hands).
At the end of each strict calender quarter in which interest payments have been made to the directors, the tax must be paid over to HM Revenue and Customs. The tax is paid in conjunction with the completion of a special form called a CT61Z. The tax has to be paid within 14 days of the end of the calender quarter. Late payments will attract an interest charge by the Revenue.
The good news is that the Gross Interest paid to the directors is a legitimate business cost of the company and can be deducted from its Profit and Loss account, thereby reducing its Corporation Tax bill for the year.
The directors, of course, are obliged to show the Gross Interest received (together with the Net Amount received and the Tax deducted by the company) in the approriate sections of their personal Self Assessment tax return forms in the tax year in which the interest was paid to them - note, this might be different to the company's annual accounting year.
If the director is only a Basic Rate tax payer, they will not be asked to pay any further tax on the interest received (even though the basic rate of Income Tax is 22% and the tax deducted on the interest was at 20%). However, if they are higher rate tax payers, they will be asked to stump up the additional full 20% as part of their 31 January Self Assessment tax bill.
Up until 31 March this year, payments of dividends are still subject to Gordon's stupid Special 19% Corporation tax charge. This is being abolished (quite right too) with effect from 1 April. This means of course, that dividends being paid NOW are being automatically taxed at 19% (irrespective of the profitability of the company).
>> Edited by Eric Mc on Thursday 2nd February 13:11
Like any organisation paying interest to an investor, the company is obliged to deduct tax at source on the interest payments. This tax is called Composite Rate Tax and is charged at a 20% flat rate on the Gross tax inclusive interest amount paid (the equivalent of 25% of the net amount paid into the directors' hands).
At the end of each strict calender quarter in which interest payments have been made to the directors, the tax must be paid over to HM Revenue and Customs. The tax is paid in conjunction with the completion of a special form called a CT61Z. The tax has to be paid within 14 days of the end of the calender quarter. Late payments will attract an interest charge by the Revenue.
The good news is that the Gross Interest paid to the directors is a legitimate business cost of the company and can be deducted from its Profit and Loss account, thereby reducing its Corporation Tax bill for the year.
The directors, of course, are obliged to show the Gross Interest received (together with the Net Amount received and the Tax deducted by the company) in the approriate sections of their personal Self Assessment tax return forms in the tax year in which the interest was paid to them - note, this might be different to the company's annual accounting year.
If the director is only a Basic Rate tax payer, they will not be asked to pay any further tax on the interest received (even though the basic rate of Income Tax is 22% and the tax deducted on the interest was at 20%). However, if they are higher rate tax payers, they will be asked to stump up the additional full 20% as part of their 31 January Self Assessment tax bill.
Up until 31 March this year, payments of dividends are still subject to Gordon's stupid Special 19% Corporation tax charge. This is being abolished (quite right too) with effect from 1 April. This means of course, that dividends being paid NOW are being automatically taxed at 19% (irrespective of the profitability of the company).
>> Edited by Eric Mc on Thursday 2nd February 13:11
Eric Mc said:
Up until 31 March this year, payments of dividends are still subject to Gordon's stupid Special 19% Corporation tax charge. This is being abolished (quite right too) with effect from 1 April. This means of course, that dividends being paid NOW are being automatically taxed at 19% (irrespective of the profitability of the company)
Hi Eric,
You've mentioned this a couple of times, but I must be having a thick day.
My very basic understanding was that dividends are paid out of profit. And that profit is taxed at 0% for the first 10k and 19% Corp Tax thereafter. I also thought I understood that the 19% Corp Tax that has been paid therefore means that you have a basic rate tax credit (22%) when assessing your income for further personal taxation. So what changes on 1st April?
Regards
Between 1 April 2004 and 31 March 2006, Gordon brown has had in place a piece of dumb legislation which makes companies pay 19% CORPORATION TAX on dividends paid to shareholders in "close" companies. Note that this is CORPORATION TAX and not Income Tax and therefore has no bearing whatsdoever on the inividual shareholder's personal tax position.
The situation for a company having a profit of under £10,000 was very unfair if it also paid a dividend.
If the company had prfits of (say) £9,500 but paid dividends of (say) £4,000, it had/has to pay a Corporation Tax amount of £760, even though it has no taxable profits.
Because of Brown's very complicated sliding scale of Corporation Tax rates, the maths works out that companies with taxable profits of £50,000 or over pay the same CT whether they paid dividends or not.
Note that the £10,000 Zero Rate band is also being abolished on 1 April 2006.
(What on earth are all your accountants NOT telling you - I'm amazed that people running their own limited companies are not completely aware of all these permutations and changes as they are VERY important things to know when deciding dividend strategy etc).
The situation for a company having a profit of under £10,000 was very unfair if it also paid a dividend.
If the company had prfits of (say) £9,500 but paid dividends of (say) £4,000, it had/has to pay a Corporation Tax amount of £760, even though it has no taxable profits.
Because of Brown's very complicated sliding scale of Corporation Tax rates, the maths works out that companies with taxable profits of £50,000 or over pay the same CT whether they paid dividends or not.
Note that the £10,000 Zero Rate band is also being abolished on 1 April 2006.
(What on earth are all your accountants NOT telling you - I'm amazed that people running their own limited companies are not completely aware of all these permutations and changes as they are VERY important things to know when deciding dividend strategy etc).
Thanks for your comments.
At present the minimal profit made by the company shows on the books as 'retained earnings' and no dividend distribution has ever been made. Corporation tax was not due on this as the company profits were less than £10k so there did not seem to be any problem.
As I understand it, from April this year 19% tax will be due on every penny of profit made by a Limited company whether or not any dividends are paid. It was recently suggested to me that the investors (eg the Directors) could received a 'reasonable commercial return' on their investment and this interest could be set against profits. I thought that this worked that every quarter the company would pay 80p of every £1 of interest to the Directors with the balance being due to the taxman within 14 days of the interest payments. The Directors would have to declare this interest received, but no further tax would be due by them as they are both on basic rate tax.
I am also now wondering what the position would be if the 'retained earnings' to date were recorded as dividends and transferred on the books to the Directors’ Loan Account, but not actually paid out in cash. Presumably from the moment the dividend allocation is recorded - even if no money actually changes hands - the Company is liable for Corporation tax and the Directors would have to declare these dividends as additional income in that tax year. However the value of the Directors’ Loan account would be increase for the long term. I would also guess that the 'retained earnings' cannot float around on the books indefinitely.
I know it’s all swings and roundabouts really, but suggestions are appreciated….
At present the minimal profit made by the company shows on the books as 'retained earnings' and no dividend distribution has ever been made. Corporation tax was not due on this as the company profits were less than £10k so there did not seem to be any problem.
As I understand it, from April this year 19% tax will be due on every penny of profit made by a Limited company whether or not any dividends are paid. It was recently suggested to me that the investors (eg the Directors) could received a 'reasonable commercial return' on their investment and this interest could be set against profits. I thought that this worked that every quarter the company would pay 80p of every £1 of interest to the Directors with the balance being due to the taxman within 14 days of the interest payments. The Directors would have to declare this interest received, but no further tax would be due by them as they are both on basic rate tax.
I am also now wondering what the position would be if the 'retained earnings' to date were recorded as dividends and transferred on the books to the Directors’ Loan Account, but not actually paid out in cash. Presumably from the moment the dividend allocation is recorded - even if no money actually changes hands - the Company is liable for Corporation tax and the Directors would have to declare these dividends as additional income in that tax year. However the value of the Directors’ Loan account would be increase for the long term. I would also guess that the 'retained earnings' cannot float around on the books indefinitely.
I know it’s all swings and roundabouts really, but suggestions are appreciated….
Both your assumptions are indeed correct. With the abolition of the £10,000 Zero Rate band, ALL of a company's profits will be subject to Corporation Tax.
If you are not desperate to pull money from the company for yourselves, I would hold off issuing any dividends until after 1 April as that is when the CT charge on the dividend itself is abolished. In fact, if you want to ensure that you allocate dividends to two separate tax years, rather than pull them all out in one year, there is that very short window of opportunity between 1 April 2006 and 5 April 2006 where the CT charge no longer applies but the dates are still within the Income Tax year of 2005/06. Dividends allocated or drawn after 5 April 2006 will fall into tax year 2006/07.
Dividends are generally deemed to have been paid on the date they were allocated to the Directors' Current or Loan Accounts - irresepective of the dates on which the cash was actually drawn from the company bank account (unless the cash draw down date was earlier - of course).
If you are not desperate to pull money from the company for yourselves, I would hold off issuing any dividends until after 1 April as that is when the CT charge on the dividend itself is abolished. In fact, if you want to ensure that you allocate dividends to two separate tax years, rather than pull them all out in one year, there is that very short window of opportunity between 1 April 2006 and 5 April 2006 where the CT charge no longer applies but the dates are still within the Income Tax year of 2005/06. Dividends allocated or drawn after 5 April 2006 will fall into tax year 2006/07.
Dividends are generally deemed to have been paid on the date they were allocated to the Directors' Current or Loan Accounts - irresepective of the dates on which the cash was actually drawn from the company bank account (unless the cash draw down date was earlier - of course).
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