Avoiding legal issues when planning profit extraction

N.TRUST Newsdesk, 27 January 2022

Directors often have misconceptions regarding their remuneration. This can sometimes have serious consequences. What does a recent High Court decision underline the importance of understanding when taking money out of a company?

Insolvency case

The High Court case of Bass and Ors v Buchanan [2021] EWHC 2740 (Ch) involved an overdrawn director’s loan account in a company providing client representation for actors. Profitability fell significantly and HMRC demanded all outstanding unpaid tax. Remuneration

The director’s remuneration pattern was typical of many small companies, the director taking low salary and high dividends. She drew money monthly from the company via standing order. After some years, there were not sufficient distributable profits to vote dividends to cover monthly drawings and the director’s loan account remained overdrawn.

Where a director’s loan account is outstanding more than nine months after the company year end, the question of corporation tax under s.455 Corporation Tax Act 2010 arises.

It’s a bright line from a tax angle, but in practice boundaries can get muddy, and this happened here. The company accountant asked their client to sign a declaration that the overdrawn loan account would be repaid instead of declaring a s.455 charge to HMRC. The loan was never repaid. The result was that the company was put into liquidation, and its sole director held liable to repay the outstanding balance on the director’s loan account - over £280,000, plus interest.

Communications

This case showed how great misunderstandings can be about the legal position when trading via a limited company. It is crucial the fact that monies drawn from the company are only on account until covered as dividends or salary. Where payments are not made as salary in real time, or if there aren’t sufficient profits from which to pay dividends, by default, monies stand to be treated as a loan.

Tthe company exists as a legal entity separate from its director, and that extracting cash from a company is completely different from taking drawings from a sole trader or partnership business. It’s not a simple ratio of hours worked to monies out; remuneration has to be voted and documented correctly.

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