Contractors, did you draw dividends after receiving a Bounce Back Loan?
If you’re a seasoned contractor you may want to skip this initial section about dividends, but if you want to truly understand why your dividends could be classed as illegal after having had a 'BBL,' or if you’re new to contracting and don’t really get dividends -- let alone illegal dividends, then stick with this intro, writes Daniel Mepham, director of SG Accounting.
Introduction to dividends in 2021
As a limited company contractor who has profit in your company, you’re able to make payments to the company’s shareholders in the form of dividends.
But in order to do so, you must ensure you hold a directors’ meeting to declare the dividend; keep minutes of that meeting (even if you’re the only director of your limited company), and include dividend paperwork in the form of a dividend voucher, which includes the date, company name, the name of any shareholders being paid a dividend and finally, the amount.
Many contractors take a low salary and tax-efficiently top-up their earnings with dividends, to keep their take home-pay as high as possible while being HMRC-compliant. Any dividends you do draw will be taxed as personal income, with the following tax thresholds being applied above the £2,000 tax-free limit:
Basic rate - (taxed at 7.5%) up to £50,000
Higher rate – (taxed at 32.5%) from £50,001 to £150,000
Additional rate – (taxed at 38.1%) £150,001 +
So where do Bounce Back Loans come into the equation?
During the coronavirus pandemic, you may have been tempted by the government offering a 2.5% Bounce Back Loan ('BBL'). But these loans must be approached with caution! These BBLs are not income and are therefore not taxable when received by the company, but if the BBL funds are drawn as dividends, then you would pay income tax based on the rates above.
How can a dividend become illegal?
If your company has made a post-tax profit this financial year, or accumulated profits over previous years, then you’re able to draw dividends up to the accumulated profits or reserves. But if there is not sufficient profits or reserves in the company to pay those dividends, then it is an illegal dividend. Sometimes this is also called an ‘ultra vires’ dividend.
So any dividends made or drawn when there is no profit is classed as an ‘illegal dividend.’ If you find yourself in this position, speak to your accountant about converting these into loans -- in order to keep HMRC happy. Instead of the money then being yours as it would if it were a dividend, it becomes a loan which is payable back to the company.
How do contractors know if there’s enough money to draw a dividend?
Unfortunately, and to truly understand your company’s reserves, it’s not as simple as viewing your company’s bank statement and seeing what is left in your account! Consult your accountant who will be able to advise how much in dividends you can pay yourself, without leaving too little to pay taxes and other bills due, and thus accidentally paying yourself an illegal dividend.
Why are Bounce Back Loans risky?
If you’re considering taking a BBL as a director’s loan for personal use, beware! These types of loans specifically state that they are ‘not for personal purposes’, which could potentially include director’s loans. You must report to HMRC any outstanding director loans at the end of your company’s accounting period.
When does the 32.5% corporation tax on loans kick in?
If you take a director’s loan from your company and fail to repay it within 9 months of your company’s year-end passing, your company will have to pay the 32.5% ‘S455’ corporation tax bill.
While this isn’t ideal, if you do end up paying the 32.5% tax you can claim it back from HMRC further down the line, once the full loan amount has been repaid. Your best bet is to only take a loan amount which you’re confident that you’re able to pay back inside the timeframe given, and therefore won’t incur any additional corporation tax.
What about personal tax on loans?
If you’re planning on borrowing more than £10,000 as a director’s loan within a tax year, your loan will be classed as a ‘benefit in kind’.
If you’re able to pay your company interest on the loan at HMRC’s official rate of 2% (since April 1st 2021), you can avoid the extra personal tax implications, which will include a National Insurance charge for your company.
Stay on the safe side
Paying yourself a low, tax-efficient salary in line with your accountant’s advice will mean you should always be paying the correct amount of tax, and therefore staying on the right side of HMRC. Before considering a loan be sure to ask yourself whether you’d be able to personally repay a loan from your company, and if the answer is ‘no’ then stick to a salary.
Remember, BBL are never to be used for personal use. As a result, insolvency practitioners will likely not accept it if you draw dividends after receiving a BBL, because having the BBL will demonstrate that there were no realised profits for the dividends to be drawn from (i.e. the dividends were illegal dividends).
They also won’t accept an increase in salary payments, as such an increase could be considered as being used for personal use. It has been rumoured in recent weeks that insolvency practitioners are insisting upon acting on a commercial basis, to try and aid politicians in closing the gaping hole in the BBL regime. Those limited company directors who fail to pay back what’s due will find that all the standard methods of collection will apply to them, including -- unfortunately -- bankrupting people and taking their homes.
If you’re unsure, seek professional help
As a contractor (whether you're seasoned or just starting out), you’re really not expected to immediately know all the nitty gritty when it comes to tax and the HMRC rules surrounding what you can and can’t do with dividends, BBLs or director loans. Be sure to speak to a contractor accountant before taking any steps to ensure you’re doing everything correctly, so that you can minimise your chances of incurring unexpected costs further down the road.