Your business is making money and naturally you want to pay yourself. That part sounds simple enough, but have you thought about how that money should be treated for tax?
Salary, dividends, expense repayments and director’s loans all work differently, and one of the common mistakes we see is money being taken first and the treatment considered afterwards. So, before you transfer money from the company to yourself, here are some of the areas worth understanding and the misunderstandings that can cause problems later.
When is a payment treated as salary?
If you are paying yourself a salary as a director, that payment should normally be processed through payroll. PAYE is then used to deal with the relevant Income Tax and National Insurance, while the company records the salary as part of its employment costs.
A common mistake is assuming that regularly transferring a set amount from the company account is enough for it to count as salary. The bank payment alone does not determine the treatment. The payroll records, deductions and reporting all need to support it.
This becomes particularly important where directors take different amounts during the year or make additional withdrawals alongside their usual salary.
When can a director take a dividend?
Dividends are different because they are paid to shareholders from profits available for distribution. They are not simply another way of withdrawing whatever cash happens to be sitting in the company bank account.
This distinction between cash and profit is important as a company may have a healthy bank balance while still having Corporation Tax, VAT, payroll costs or supplier payments to meet. Equally, cash in the account does not necessarily mean the company has sufficient distributable profits to support a dividend.
The mistake can therefore be assuming that available cash means a dividend can be paid. Before declaring one, the company needs to check that sufficient profits are available and make sure the dividend is properly recorded.
When does a director’s loan arise?
A director’s loan is money that moves between a company and one of its directors, outside normal salary, dividends, or reimbursed business expense. A director’s loan can arise when money is paid into the company from a director or the company loans money to a director for personal reasons.
These are recorded through the director’s loan account. If the director has taken more from the company than they have put in, the account may become overdrawn, meaning the director owes money back to the company.
The tax mistake often comes from allowing withdrawals to build up without keeping track of how they are being treated. An overdrawn director’s loan can have tax consequences depending on the balance and how long it remains outstanding, so it is better to understand the position during the year rather than only when the annual accounts are prepared.
What about expenses paid personally?
If a director pays a genuine company expense personally, the company may reimburse them. That repayment is different from salary, a dividend or a loan, but the business still needs to be able to show what the payment related to and why it was a company cost.
Problems can arise when expense repayments become mixed with personal spending or general withdrawals. Once different types of payment are grouped together, it becomes harder to establish the correct accounting and tax treatment later.
Know how the payment should be treated before it is made
The key is to understand what money taken from the company corresponds to before it is transferred. Salary, dividends, expense repayments and director’s loans all have different rules, and treating one as another can create unnecessary tax or reporting issues.
