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As a responsible small business owner, it is crucial that you have a comprehensive understanding of the potential tax and National Insurance (NI) consequences that may arise from utilising your cash reserves. Taking out a short-term loan from your business could have significant implications that may impact your financial stability in the long term. Therefore, it is advisable to carefully consider the possible outcomes before making any decisions. By doing so, you will be able to safeguard your business and avoid any negative consequences arising from mismanagement of your finances.
Ups and downs: All businesses have financial ups and downs; the same is true for business owners. In the latter case, you can borrow from your business to tide you over, regardless of what HMRC may think this is, subject to conditions and consequences entirely permissible.
Incorporated or unincorporated: The first important point is that the position for companies, even one-person companies, is entirely different from that for unincorporated businesses, i.e. sole traders (self-employed) or members of a partnership (including a limited liability partnership).
Unincorporated businesses: If you draw cash from your business bank accounts or use them to settle personal bills, there are no direct tax or NI consequences. Your tax and NI bill is based on your business’s profits rather than how much cash you draw. So even if you borrowed money from your bank to fund you over this tricky period, it wouldn’t count as taxable income.
Companies: The tax position is very different if you’re a director shareholder of a company. Every cash payment or personal bill paid by your company can count as taxable income, i.e. as salary, dividends, or benefits in kind, each with the usual tax and NI bills and compliance requirements that go with them. Alternatively, you can treat the cash you take as a loan; this isn’t necessarily free of tax consequences but is generally a cheaper and more flexible arrangement.
Tip: The good news is that where your company is indebted to you, say because you lent it money to get it up and running, you’re entitled to treat any cash taken or bills paid on your behalf as non-taxable.
Trap: To prevent unnecessary tax liabilities resulting from drawing or using your company’s cash for personal benefit, keep accurate records indicating how you have categorised the money taken from your company. If you don’t, HMRC might argue that the cash you take is salary on which PAYE tax and NI are payable, which you should have reported through your payroll software. Failure to do this can result in penalties.
Timing and proper record keeping: If you want to treat the cash you take from your company as a loan, keep a board minute or written record of making sure the bookkeeper knows to record the transaction as a debit to your director’s loan account. If later you want to clear all or part of the debt you’ve built up with your company, you can approve a dividend or bonus. But rather than drawing the cash from your company, you can ask your bookkeeper to use the dividend or bonus as a credit to your loan account.
Tax efficiency and the rollercoaster of business finances: Small business owners may occasionally dip into their company’s cash reserves to stay afloat during challenging times. What are the tax and NI implications of obtaining a short-term loan from your enterprise?
Riding the financial waves: All businesses face fluctuations in their financial stability, and business owners are no exception. Borrowing from your company to weather the storm is entirely possible, but be prepared for specific conditions and repercussions, despite what HMRC might think.
Business structure matters: It’s crucial to distinguish between the tax implications for incorporated entities, including single-person companies, and unincorporated businesses, such as sole traders or partnership members.
Unincorporated businesses and cash access: For unincorporated businesses, withdrawing cash from business accounts or using them for personal expenses doesn’t directly impact taxes or NI. Instead, tax and NI calculations are based on business profits, not cash withdrawals. Consequently, securing a bank loan during a challenging period won’t be considered taxable income.
A different story for companies: For director shareholders, the tax landscape is quite different. Any cash payments or personal expenses covered by your company could be treated as taxable income, such as salary, dividends, or benefits in kind. Each of these is subject to tax and NI, along with compliance requirements. Alternatively, you can view the cash taken as a loan, which may have tax implications but is generally more flexible and cost-effective.
Silver lining: On a brighter note, if you initially lent your company funds to launch it, any cash withdrawn or bills paid on your behalf are considered non-taxable.
Pitfall prevention: To avoid unnecessary tax liabilities from using your company’s cash for personal purposes, maintain meticulous records that detail the classification of funds withdrawn. If not, HMRC could argue that the cash taken is salary subject to PAYE tax and NI, which should have been reported through payroll software. This oversight could lead to penalties.
Timely documentation and bookkeeping: If you treat cash taken from your company as a loan, ensure a board minute or written record is kept so the bookkeeper can record the transaction as a debit to your director’s loan account. If you later wish to clear part or all of the debt accrued, you can authorise a dividend or bonus. Instead of withdrawing cash from your company, ask your bookkeeper to credit the dividend or bonus to your loan account. If you need help to plan your taxes, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.