Running your business as a limited company has many potential benefits both for taxation and for financial liability. However, there are added accountancy and tax complications that new director owners are not always aware of.
A limited company is a totally separate legal entity to you as a director. It is responsible for its own tax and for calculating any taxable benefits that arise on its employees. This includes you as a director because you will probably be an employee of the company.
It is therefore much more important to be meticulous with your accounting and to avoid mixing personal monies or assets with company ones, otherwise tax implications and additional costs will arise. Be strict with yourself, particularly with the company money and keep personal monies and expenses totally separate, including separate bank accounts.
Do not be tempted to use the company funds as a personal piggy bank. This is the biggest mistake new owner directors make and the tax consequences and accountancy costs can be severe.
Shares and shareholders
When you set up a limited company, the company will issue shares which you as the director will purchase to become a shareholder in the company. At the beginning it is common to issue just one ordinary share of nominal value £1. The £1 you pay for the share in the company is the capital you are limited to losing if the company becomes insolvent.
In reality you may stand to lose more if you inject personal money into the company for cash flow reasons or introduce personal assets. This is actually a loan of money you are making to the company and you may not get it back if the company fails.
The director's loan account (DLA)
When you put your own personal money into the company including introducing any capital assets such as equipment, you are effectively loaning capital to the company. This will result in the creation of a director's loan account (DLA). The company can pay you back this capital in the future just like it would pay back money on a loan from the bank. The capital that you subsequently withdraw from the DLA will be tax free (provided you don't charge interest on the loan).
However, if the DLA becomes overdrawn i.e. you take out more money than you have lent to the company, you are liable to a tax charge depending on the amount and the circumstances. We recommend you avoid taking out more money from the DLA than goes in at all times as it will cause additional accountancy issues and costs.
You must avoid at all times paying private bills from the company funds during the year unless you are 100% certain that there are sufficient funds in the DLA. It is not sufficient to simply add funds at the end of the year to balance an overdrawn DLA. Tax inspectors are looking out for this and any timing differences may be identified.
Salary and dividends
Often the most tax efficient way to pay yourself as a director is to pay a salary which utilises your tax free personal allowance. That way you will not pay tax on the salary but you will still contribute a little amount in the way of NICs to maintain your eligibility for the state pension and other benefits.
The company will then pay corporation tax on the remaining company profits after deducting your salary as an allowable expense. Dividends may then be paid out of the remaining profits to you as a shareholder. You may have further tax to pay on these depending on the amount you receive. You must understand however that dividends are paid out of the profits generated by the company. It is illegal to pay dividends unless the company has generated sufficient reserves through profits over the years.
The timing of dividend payments is therefore important because you cannot pay them unless profits have been generated. If you are going to pay yourself dividends rather than a salary, you must not take the money out of the company unless you have calculated your profits in accordance with standard accounting practice and declared by resolution that a dividend may be paid. This includes paying interim dividends throughout the year. It is therefore not acceptable to simply pay dividends at a whim during the year without first establishing whether you have profits and reserves.
If you want to take a fixed amount out of the company each month without worrying about calculating profits, you may be better off paying yourself a higher salary. However, if you have significant reserves from previous years or a large credit balance on your DLA, you may be able to pay lump sums without concern. We can help you decide if you can do this.
There is no legal requirement to pay a director a salary. However, if you have a contract of employment with the company, you must be paid at least the minimum wage. It is worth noting that it is usually best to have a contract of employment with the company if you want to claim certain state benefits such as working tax credits. This will prove your eligibility beyond doubt and avoid potential disputes over your actual working hours.
Assets and invoices in the company name
Most assets that are used in the business should normally be in the company name. You will not be able to legitimately claim tax relief through capital allowances if they are in a private individual's name such as a director. However, it may be more tax efficient and less complicated to leave assets such as land and property or company cars in your personal name. We can help you discuss the options available.
Invoices (especially things like mobile phones) should be in the company name wherever possible, otherwise there is a potential taxable benefit and a requirement to report the expenses paid by the company on behalf of a director via a P11D. We recommend transferring any contracts that are in your personal name to the company.
Where assets or services are in the company name and the director uses the asset or service for some private use, there is the potential for a taxable benefit to arise. This will be treated as taxable income for the director and the company will have to pay Class 1A National Insurance Contributions on the amount. It may sometimes be advisable to avoid including some assets and services within the company to avoid this scenario.
It is often more tax efficient to leave directors' cars outside of the company to avoid a taxable benefit arising and instead pay the director the tax free mileage allowance for business travel. Whether this is the case for you will depend on your circumstances and the original list price of the car, but we can help you decide.
Use of home
If you run your company from home you are entitled to claim for the associated costs. The company can pay the director the tax free monthly allowance (currently £26 per month) without any record keeping or reporting. Alternatively, if you think your costs are greater than this, you can pay a higher amount but you must keep records of how it has been calculated (eg based on floor area and time) and retain supporting invoices etc.
Another alternative is to set up a rental agreement with the company, whereby the company pays a weekly rent for using part of the building. The company gets tax relief on the expense but the director must report the rental income on the property pages of the self assessment form. However, the costs of running the property rental business will be tax deductible too such as utility bills, insurance and council tax etc.
However, capital gains tax may be payable when you dispose of a property (or part of) that has been used exclusively for business purposes.
This information is not meant as a substitute for professional advice and by no means covers every scenario. Almost every rule described here will be subject to many exceptions and caveats. Tax legislation is extremely complex and can be difficult to understand. You should discuss your circumstances with a qualified professional before acting on any information contained within this website. Tax legislation is constantly changing and the information contained within this website is written from our current understanding and interpretation of the tax system as of 6 April 2020.