A Limited Company contractor’s guide to bounce back loans, dividends, and illegal dividends

An introduction to dividends – new to contracting

If you’ve been contracting for a while we’d suggest skipping this first section, but if you’re just starting out in your contracting career or thinking about it, you may be needing some advice on what a dividend actually is.

If there’s profit in your Limited Company, you’re able to draw payments to your shareholder/s in the form of dividends. You’ll need to hold a director’s meeting where you’ll declare the dividend, keep minutes of the meeting, and include a dividend voucher (paperwork detailing the company’s name, dividend’s amount, date it was issued and who to).

Your company won’t pay tax on dividends that are less than £2,000 in value, so you may wish to use a combination of a low salary that’s then topped up with dividends as a way of paying yourself. This method allows you to pay the smallest amount of tax, whilst keeping a high monthly take home pay and remaining tax compliant. As drawn dividends are taxed as personal income, the following thresholds are applied over the £2,000 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+

It’s always advisable to run your dividends and salary plans past a specialist contractor accountant, to ensure everything is done correctly.

Bounce back loans

During the pandemic did you ever get tempted by the 2.5% Business Bounce Back Loan (BBL)? Before you take the leap, beware! Whilst BBLs are not taxable when your company receives them, if your company draws the funds as dividends then you’ll have to pay income tax based on the rates above.

Why is this the case and what’s classed as an ‘illegal dividend’?

So long as there’s post-tax profit in your company, or your company has accumulated profits or reserves over previous years, then you’re able to draw dividends. If your company doesn’t have sufficient funds and you draw dividends, it is classed as an illegal dividend (also known as ‘ultra vires’). If you find yourself in this position, be sure to speak to a specialist contractor accountant who will be able to convert these into loans to keep the taxman happy. This makes the money a loan rather than a dividend, so you’ll need to pay it back to your company.

How do you know if there’s enough money in your company to draw a dividend?

You’ll need to speak to your accountant who will be able to give you accurate information on how much you’ll be able to pay yourself as a dividend, whilst ensuring there’s enough left to cover the taxes and other bills due, which could accidentally result in you paying yourself an illegal dividend.

What’s the associated risk with Bounce Back Loans?

Be sure to tread carefully if you’re considering using a Bounce Back Loan (BBL) for personal use. It’s clearly stated that you’re not allowed to use a BBL for ‘personal purposes’ which could include director’s loans. You will need to inform HMRC of any outstanding director’s loans at the end of your company’s accounting period.

32.5% Corporation Tax on loans – when will this take affect?

If you do not pay back a director’s loan within the 9 months and 1 day timeframe, your company will be liable to pay the 32.5% ‘S455’ Corporation Tax bill. Once you’ve repaid the full amount of the loan, HMRC will reimburse you for the 32.5%. It’s advisable to only take out a business loan that you’re confident you’re able to repay, therefore removing any risk of having to pay the S455 tax bill.

What about personal tax on loans?

If you borrow more than £10,000 as a Director’s Loan within one tax year, your loan will be classed as a ‘Benefit in Kind’ (BiK) by HMRC. If you’re able to pay your company interest on the loan at HMRC’s official rate (2% from April 1 2021), you’ll avoid the extra personal tax implications, which will also include a National Insurance charge for your company.

How to stay on the safe side

By paying yourself a salary you’ll know that you’ll always be paying the correct amount of tax to HMRC, and keeping them happy. Before agreeing to a loan be sure to ask yourself whether you’re able to pay it back personally, and if the answer is ‘no’ then it’s best to stick to a salary and ask your accountant about your available options (if any).

Remember that BBLs must never be used for personal use, and insolvency practitioners will not be likely to accept one should you draw dividends after receiving one. This is because once you’ve drawn a BBL you’ve demonstrated that there were no released profits in the company to draw dividends from, and therefore you’d only be able to draw illegal dividends. Be aware that this also includes an increase in salary payments, as this also could be considered as being used for personal use.

Some insolvency practitioners have said to some contractors that they will be acting on a commercial basis, in an attempt to aid politicians in dealing with the gaping hole in the BBL regime. Any contractors who fail to pay back what they owe may find that all standard methods of collection will apply, including the possibility of bankruptcy and repossessing people’s houses.

Now is the perfect time to get the support of a specialist contractor accountant

Be sure to run over the subjects covered in this blog with your contractor accountant, as they will know your personal and professional needs along with your company’s accounts, and be able to give you tailored advice that’s best suited to your needs.

Here at Aardvark Accounting we make it our business to know yours, and to be able to offer you specialist advice that’ll help you bring home as much as your contractor pay as possible, whilst keeping the taxman happy. If you’re new to contracting, we can help you get started, answer all your questions, and get you contractor ready for your first contract. Or if you’re already contracting but looking to switch, we can offer you better value for money for a superior service. Get in touch with us today to find out more.