Running Your Company as a Director: Key Differences & Responsibilities

Running a company as a director is fundamentally different from operating as a sole trader. While you may own your company, it's crucial to understand that a limited company is a completely separate legal entity to yourself, the owner(s).

As a sole trader, you and your business are indistinguishable. However, with a limited company, this is not the case. Many directors don't realise this and mistakenly treat the company's property and finances as their own.

Being an entity in its own right means you cannot treat the company's assets as your personal possessions, such as simply drawing £50 from the business bank account. You are two separate beings with your own separate possessions.

Common Mistakes Directors Make and Practices You Should Adopt

Taking Money Out of the Business

As mentioned, you cannot simply take cash out of the business just because you own it. The bank accounts and their contents belong entirely to the business.

Legitimate ways to extract funds include:

• Taking a salary through your payroll, where the necessary tax deductions (PAYE and National Insurance) are made.
• Taking dividends provided the company has sufficient distributable profits to do so legally.

Anything else that you take from the business will typically go into your Director's Loan Account which we will discuss in more detail below.

Personal Purchases 'on The Business'

It's easy to fall into the mindset that you can pay for personal items like a takeaway or Christmas presents using the business card or account. However, doing so is similar to taking cash out directly: the amount goes into your Director's Loan Account and may have significant tax implications.

Your accountant may also charge you more for processing such personal purchases appearing on your business accounts. Each personal transaction represents extra work to categorise correctly, and these purchases can skew the 'snapshot' of your business's true financial standing.

Business bank accounts should *only* be used for the legitimate funds flowing in and out of the business. Remember, it is a separate entity from you – you wouldn't just use a friend's bank account without keeping careful track of what you owe them. This tracking is precisely what the Director's Loan Account is for!

Business Purchases Reimbursed

On the other side of the coin to personal purchases made on the business, you may occasionally pay for some business expenses yourself and then need to reimburse the cost to yourself or an employee.

This is permissible, but you still need to retain the original invoice or receipt, and you must maintain these records diligently, as you always should. Ideally, everything should be invoiced to and paid directly by the business. However, where odd reimbursements are made, ensure you submit all relevant documentation to your accountant for proper recording.

The Director's Loan Account (DLA)

Anything you take out of the business that isn't legitimately accounted for in the business's records (e.g., salary, dividends, properly reconciled expenses) – such as taking cash out to buy a takeaway – gets assigned to your Director's Loan Account (DLA).

Similarly, any money you put *into* the company from your personal funds also goes into your DLA. This either reduces any amount you've borrowed from the company or creates a liability, meaning the company owes you money.

There are significant tax implications if, at the end of the financial year, you owe money to your company:

• The outstanding balance can be treated as a loan and may be subject to interest charges.
• The company may have to pay a specific tax (known as S455 tax or close company loan charge) on the Corporation Tax Return for any balance you owe that isn't repaid within nine months and one day of the company's year-end.
• You may also owe income taxes as an individual for the benefit of the loan.

For these reasons, it is strongly advised not to owe your company anything on your Director's Loan Account wherever possible. You should also be aware of a practice known as "Bed and Breakfasting" Director's Loans.

You can find more official guidance here: gov.uk/directors-loans/you-owe-your-company-money

Bed and Breakfasting: A Director's Loan Pitfall

What is Bed and Breakfasting?

Bed and breakfasting is a financial manoeuvre that involves temporarily repaying a director's loan to a company just before the end of the tax year, and then immediately borrowing the same amount back shortly thereafter. Essentially, it's like checking out of a financial “bed” (repaying the loan) and then checking back in (borrowing the funds again) the next day or soon after.

Why Do Directors Engage in Bed and Breakfasting?

• Tax Avoidance: Directors may use this strategy to manipulate their tax liability. By repaying the loan before the tax year ends, they aim to avoid paying the S455 tax on the outstanding balance. Then, by borrowing the funds back, they effectively reset the loan without incurring immediate tax consequences.
• Avoiding S.455 Tax: In the UK, when a company lends money to its director (or a close associate), it's considered a “benefit in kind.” If the loan isn't repaid within nine months and one day of the company's year-end, the company must pay a tax called S.455 tax (also known as the “close company loan charge”). Bed and breakfasting aims to sidestep this tax.

Why Should You Avoid It?

• Tax Authorities Are Watching: HMRC is well aware of bed and breakfasting tactics. Engaging in such practices can raise red flags, lead to investigations, and potentially result in significant penalties.
• Ethical Considerations: While some might attempt to argue its legality, bed and breakfasting is generally seen as an unethical way to manipulate the tax system. It undermines the spirit of tax laws and fairness.

How to Avoid Bed and Breakfasting:

• Plan Ahead: If you need to borrow from your company, plan the loan carefully. Avoid last-minute manoeuvres to repay and re-borrow.
• Consider Alternatives: Explore other legitimate financing options for taking money from your company, such as a regular salary or dividends, rather than relying solely on director's loans for ongoing personal funds.

Remember, transparency and ethical financial practices are essential for maintaining trust and credibility, both personally and for your company.

Further official guidance on this specific area can be found here: gov.uk/hmrc-internal-manuals/company-taxation-manual/ctm61630

Dividends

Dividends are sums of money taken out of your company as a return for your capital investment in it, specifically your shares.

You may take dividends several times per year, or once per year, but there are crucial rules to follow:

• The company MUST have sufficient distributable profits to pay the dividends. If your company does not have the available funds (after accounting for expenses and other liabilities) to pay them, the dividends are illegal.
• If the company doesn't have the equity to pay the dividends, in addition to being illegal, the amount will be treated as an overdrawn Director's Loan Account.
• Dividends are not a business expense and so are not recorded as such in your company's profit and loss.
• They are always paid after Corporation Tax. This means Corporation Tax is paid on the company's profits (including the amounts that will be paid as dividends) before the dividends are paid to shareholders.
• There is an annual tax-free allowance on Dividends for individuals, but anything over this allowance has tax implications for the individual. They will typically have to complete a Self Assessment Tax Return to declare this income and pay the relevant income tax.

In essence, dividends are your share of the company's profits, distributed to shareholders after the company has paid its Corporation Tax.

There are several detailed rules and requirements governing Dividends which you should look through on the Gov.uk website.

More general guidance on company responsibilities can be found on the Gov.uk website. While it might not go into all the granular details we've covered here (which is why we created this guide!), you should absolutely familiarise yourself with your legal and tax responsibilities there. They also have a few useful tools to help you.