Why it is vital to understand the separation between you and your limited company.

In law a company is a separate legal entity, or legal person from its owners (shareholders) and from its directors. A company can own property, enter into contracts, employ people, sue and be sued and even be charged with criminal offences. It is important to understand that even if you are the sole director and 100% shareholder in the eyes of the law you and your company are different people.

“A company can own property, enter into contracts, employ people, sue and be sued and even be charged with criminal offences”

It is important, if you are a company director and owner to understand the separation because it brings both benefits and also some negative consequences.

Benefits of separation

When the brown stuff comes into contact with the spinning thing this separation can be a huge benefit. If your company is sued or charged with a criminal offence, as a director you are protected by what is known as the veil of incorporation. So as long as you personally have acted legally and fulfilled your responsibilities as a director you cannot be sued or charged personally for things the company has done.

As a company director it is vital to understand your duties as a director because if you breach those duties the veil of incorporation can be lifted. That means you could be personally liable for the actions of the company. For a detailed explanation of your directors duties see 7 Things Every Company Director Must Know.

“…as long as you personally have acted legally and fulfilled your responsibilities as a director you cannot be sued or charged personally for things the company has done.”

Another benefit, especially for small business owners is the opportunities for tax planning that running your business through a limited company brings. At the time of writing corporations tax is a flat 19%. Depending on your income level this could be significantly lower than your personal tax rate.

Once the company has paid its 19% corporations tax the company owners (you) can’t just start spending wildly with what is left. I’ll go into this a little bit more shortly but a company’s post tax profits are still its profits and not yours. This is where is gets a little bit complicated, but it is not until you have withdrawn the money from the company that it becomes yours to spend.

There are essentially three ways for an owner director to get money out of there company. The first is repayment of the directors’ loan. This is covered in detail in Never Dance with the Debit . In short most company directors lend their company money when they set it up and it’s common for directors to pay expenses of the company out of their personal pocket. These, if not reimbursed all add to the directors’ loan account. If a director has a credit directors’ loan account (the company owes him money) then as long as certain conditions are met (covered in Never Dance with the Debit) they can withdraw this amount as a tax free loan repayment.

There are essentially three ways for an owner director to get money out of there company. The first is repayment of the directors’ loan. This is covered in detail in Never Dance with the Debit . In short most company directors lend their company money when they set it up and it’s common for directors to pay expenses of the company out of their personal pocket. These, if not reimbursed all add to the directors’ loan account. If a director has a credit directors’ loan account (the company owes him money) then as long as certain conditions are met (covered in Never Dance with the Debit) they can withdraw this amount as a tax free loan repayment.

The second way a director can take money from their company is by paying themselves wages. Directors’ wages are a tax deduction for the company, so they reduce the amount of 19% corporation tax that the company must pay, however they have other tax consequences, for both the company and the individual that need to be considered.

For the company, any week in which the wages paid is above the National Insurance Secondary Threshold (£169 per week, £732 per month or £8,788 for the 2020/2021 tax year) employers national insurance will need to be paid. This means that the company will need to be registered for PAYE and Real Time Information (RTI) payroll reporting.

For the individual, any week in which the wage is greater than the National Insurance Primary Threshold (£183 per week, £792 per month or £9,500 per year for the 2020/2021 tax year) employer’s national insurance will need to be paid. This tax is paid at source (deducted from your wages by your employer) which also means that the company will need to be registered for PAYE and Real Time Information (RTI) payroll reporting.

For the individual, any week in which the wage is greater than the National Insurance Primary Threshold (£183 per week, £792 per month or £9,500 per year for the 2020/2021 tax year) employer’s national insurance will need to be paid. This tax is paid at source (deducted from your wages by your employer) which also means that the company will need to be registered for PAYE and Real Time Information (RTI) payroll reporting.

If the wages are above the individual’s personal allowance then the individual will also be required to pay PAYE tax. This allowance starts at £240 per week, £1,042 per month or £12,500 per year for the 2020/2021 tax year. However if the individual has total income of over £100,000 then the personal allowance is reduced by £1 for every £2 above £100,000.

If all of this makes you think it is too complicated to pay wages from the company think again. There are two reasons why you should. Number one is that as long as you keep the total below the National Insurance thresholds you will reduce your corporations tax and get (currently) around £8,500 out of the company tax free (as long as your personal allowance hasn’t been reduced to much due to your earnings over £100,000)

The second reason is qualifying years for national insurance. This will be covered in detail in Protect Your Pension. In short, in order to qualify for state pension you need at least 10 qualifying years and in order to get the maximum state pension you need 35 qualifying years. A qualifying year is any year in which your total wages was above the national insurance Lover Earnings Limit. For the 2020/2021 year this was £6,240.

“…get a qualifying year for state pension, reduce your corporations tax and get money out of the company tax free…”

So if you pay yourself a wage for the 2020/2021 year of more than £6,240 but less than £8,788 you will get a qualifying year for state pension, reduce your corporations tax and get money out of the company tax free. I hope you followed that!

The third way of getting money out of your company is by paying dividends.

Dividends are how a company distributes its post-tax profits to its owners (shareholders). So when you take money out as dividends you have already paid 19% corporations tax on that money. The good news is that to take account of this dividends are taxed as lower rates than other personal income.

At present, where normal personal tax is 20% dividend tax is 7.5%, where normal personal tax is 40% dividend tax is 32.5% and where normal personal tax is 45% dividend tax is 38.1%. As well as this there is currently a £2k dividend tax free allowance, which is additional to the usual £12.5k personal tax free allowance.

Importantly dividends do not attract national insurance. This makes paying dividends more tax efficient than just paying wages, but also means that you will not earn state pension qualifying years by paying dividends. That is why it is important to combine dividends with the right level of wages.

Consequences of separation

How you get your money out of your company is fundamental to this topic because it highlights the distinction between the company’s money and your own. Once you have got your money out of the company you are free to do what you want with it – although don’t forget you may have to pay personal tax on it!

Importantly while the money is still in the company it is not your money. You are not at liberty to use it for your own purposes. This also goes for the company’s assets. It is too big a topic to go into detail here, but there are tax consequences if you use the company’s assets personally. The obvious example here is the company car.

Photo by Aleksey Kuprikov on Pexels.com

It used to be popular for people to buy their car in their company so that its cost could be deducted for corporation’s tax purposes. However if the car belongs to the company it is the company’s car and not yours. Using the company car for personal journeys is a benefit in kind, and for a long time now the personal tax payable on this has outweighed any corporation’s tax benefit.

What it all means

When you are the owner / director of a profitable limited company you can take the profits out throughout the year to fund your living costs. You just need to always be aware of two things:

  1. How much you can take out. As a general rule as long as you leave enough money in the company to pay your creditors and tax bills you can take out as much as you like (see 7 Things Every Company Director Must Know).
  2. Once you’ve taken it out, how much must you put aside for personal tax.

Keeping on top of these two things can be devilishly complicated, especially the 2nd one. The great news is that as an LCCS client you have access to our unique Live Tax Report. With just a few simple inputs this report will tell you exactly how much you can take out of your company and importantly, exactly how much you need to put aside for personal tax. What’s great about this is that come the end of the year you know how much corporation’s tax and how much personal tax you’re going to have to pay. You don‘t have to wait months for your company accounts to be done, there are no surprises and if you’ve followed our advice all the money has already been put aside.

See: Never Dance with the Debit (Directors’ Loan Account)

See: The seven things all company directors must know and why it’s necessary.

See: Protect Your Pension – What every company owner needs to know about NIC’s, Qualifying Years and State Pension (Coming soon)

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