Lets say that two friends are planning to go into business together and that each has borrowed 10K to use as start up capital
The business will be in the form of a Ltd company - with the share capital being divided 50 - 50.
They both have repayments on their respective 10K loans.
My question as follows:
Would they be well advised to transfer the 20K under a loan agreement? By this I mean as it would relate to the tax implications?
For instance one of the directors is already employed with full time job (and will not be undertaking any paid duties for the company). Thus if he made a loan to the company; how would the repayments be treated for tax purposes i.e. would he have to pay Income Tax on them?
We're planning to get an accountant in the very near future but I just thought I'd ask the group first.
Surely the only other way to do it is to have them put the money in as share capital; but then there is no interest and no repayment - they only get dividends.
If the loans to the company were interest free, there should be no tax implications. But make sure the paperwork is correct to ensure that the IR will not classify it as net remuneration and thus subject to PAYE & NI on the grossed up amount(s).
There is no VAT on loan interest, so if this is leading to where it normally does, forget it. :-)
There would of course be no tax on any capital repayments, only on interest received. He would have to pay tax on that amount of interest he receives from the company, which exceeds the interest he pays to the lender. If the difference is zero, there is no benefit to be taxed.
But if the company pays more interest than the lender takes, then he does receive a taxable benefit. Ah, wait, I think I can see where it's leading. Are you thinking what if the company profit is in the £10k-£50k band and therefore pays corporation tax at a marginal 23.75%? Then if the company pays the directors via excessive loan interest what it would otherwise pay as dividends, there could be a tax saving, because the company would not be taxed on interest (it's an expense) and the director would have to pay tax at the savings interest rate of 20%/40%, whereas if the same excess were paid as dividend, it would not be an expense to the company and so would be taxed at 23.75%, with the director then paying an extra
0%/25% on the dividends received. The effective rate of tax to the director would be 23.75%/42.81%, and so its cheaper to get the dosh as interest than as dividend.
The position is reversed where the company profit is below £10k or above £50k but below £300k, since the corporation tax rates are 0% (giving an effective 0%/25%) and 19% (giving an effective
19%/39.75%). Since in both cases the effective rates are below
20%/40%, he's pay less tax by taking the dosh as dividends.
Above £300k, and especially if below £1500k, the situation is reversed again, and he'd pay less tax by taking the money as interest.
Chances are the IR have this sussed and will re-classify any excessive interest as dividends if it suits them.
With a loan, you have a slightly better chance of getting the money back if the company goes bust.
Also, it is easier to get the capital repaid. With dividends, you would have to wait until the company makes profits before you can get the money back. With loans, you can get the money back any time, subject to available funds.
What sort of areas do you think we should get advice on? For instance what should I say when I ring up the accountant to arrange for an appointment?
Basically we're just a trading company. That is I buy goods from the US then and sell them via Ebay.co.uk (and we do plan to have our own website in the near future).
Hi Andrew, no point - this was just an honest question. You see I wasn't sure if the repayments would be subjected to Income tax or not
I thought that perhaps we'd just have to transfer the 20K as a sort of "gift". Then that we would both have to repay the loans with money taken as wages from the profits - which didn't really appeal.
Not today Ronald - although that "same old scheme" keeps poping to mind from time to time (one day I'll get it to work or least understand why it can't)
full
pay
of
interest
This is just what I wanted to hear.
Nope, there was no ulterior motive to the question, wasn't thinking about CT whatever. I'm hoping that if we just pay ourselves the absolute minimum and that all the profits are reinvested in stock then CT shouldn't really kick it. Then we work just work on building a "nest egg" and then figure out how we can get our hands on it in it in the most tax-efficient manner possible.
It doesn't quite work like that. If the company makes £20k profit in year 1, there will be CT of £2375 to pay. You can therefore only re-invest £17625.
The usual method is to pay yourself dividends instead of salary. If your friend already has a normal job and you don't, you should pay yourself a salary of £4615, thereby escaping both income tax and NI, while nevertheless being credited with NI-qualifying years towards your state pension. Pay yourself the rest as dividends. They will be free of income tax until you reach the higher rate tax threshold, whereupon the excess will be taxed at 25%, but no NI is payable.
Even if you don't need the money, it's probably best to pay yourself the maximum possible dividend which net profits (and your non higher-rate taxpayer status) allow, and the re-invest the money in the company as a loan. That way you can get the money out again in the future without it being taxed (since it is already yours).
For small owner managed companies, they generally don't.
The advantage of shares to the company is that they don't have to pay anything if they don't have the money. It works out more expensive though. The advantage to the shareholder is that they get a vote.
No you don't. For starters, you could sell the 100 £1 shares for £200 each if you wanted to, and you could also lend the money to the company rather than use it to buy shares. It is probably better to lend it anyway.
The bank is going to ask for a personal guarantee whatever way you do it.
This would be allowable business expenditure so "the 20k in year
1" would be deducted leaving 0 liable to CT
Is this not correct?
I've heard of this but to be honest I don't really understand (or at least not really in this case).
I know of course that it is usual for shareholders to receive a share of the companies profits and that this is generally paid via a dividend. That said I always assumed that this type of investment would be subject to some kind of tax.
For instance if someone buys say 100 shares of ICI:
Would they not pay tax on the dividends? And further be liable for Capital Gains on any increase in the share value?
Do the rules differ between PLC and LTD?
should
years
So could I pay myself a dividend of 26885 and this would be free of any type of tax?
So 26885 + 4615 salary = 31500 per year for me free of Income tax and NI
subject to
Perhaps they meant Capital Gains tax instead of CT (does this make more sense?).
Buying stock is not an allowable business expenditure in the way you think. Profits are the difference between sales and purchases, but when working out the profit it's only the purchase cost of goods sold that you deduct from sales income, not the purchase cost of stock in hand.
You start with £20k invested cash which you turn entirely into stock, which you sell at 100% mark-up and end up with £40k cash. That means you've made £20k profit. It makes no difference whether you turn half or all of the money into new stock, the company still owns £40k worth of stuff (being either money or stock) which is £20k more than it started with. It would be unwise not to convert all the cash into new stock, unless you're confident you will have generated at least enough cash from new sales by the time the tax on profit becomes due.
Yes, but dividends come with a built-in tax credit which is enough to meet the income tax liability of those dividends unless the recipient is in the higher tax bracket. So a "normal" taxpayer pays no tax on dividend income.
Yes, but not until they're sold.
No, but with small LTDs you generally only issue shares to a negligible nominal value, and inject the serious cash as loans instead of share capital.
Yes in principle, not quite correct with the old numbers, old chap, which seems to be one of your weaknesses (explains why you can't understand why VAT scams are impossible).
The higher rate tax threshold is £30500 *of taxable income* (you seem to have inflated it by £1000 for some reason), and the £4615 personal allowance is *in addition*. Therefore you can pay yourself £4615 as salary free of income tax and of NI, *plus* £30500 of dividend income, on which there is no NI anyway, also free of IT. This assumes you have no other income whatsoever, such as from bank interest or capital gains. On each extra £1 of dividend you would then pay 25p income tax, as a result of a process too complicated for you to understand.
No, I think he meant what I illustrated above, that the sales profit remains taxable even though the money by which it is represented has been converted into stock.
No. Lets look at a simple example. You buy widgets for £1 each, and sell them for £2. No other expenses. In year one, you buy 20,000 widgets, and sell them all. At the end of the year, you buy another 20,000 widgets for sale next year.
Your accounts would look like this:
Sales 40,000
Cost of Sales
Purchases 40,000 less closing stock (20,000) ------ (20,000) ------ Profit before tax 20,000
Tax (2,375) ------ Retained Profit 17,625 ===== Next year, you sell these widgets, and buy another 20,000 at the end of the year:
Sales 40,000
Cost of Sales
Opening stock 20,000 Purchases 20,000 less Closing stock (20,000) ------ (20,000) ------ Profit before tax 20,000
Ah, OK. So to escape all tax you must to pay yourself no more than £27450 of dividends, which count as £30500 gross minus 10% tax treated as paid.
So a total of £4615 salary plus £27450 dividends, or £32065 all told.
Then the next £9 of dividends you pay yourself will count as £10 gross, on which higher rate tax is due at the special dividend rate of 32.5%, but of which 10% are already deemed paid, leaving 22.5% payable, but
BeanSmart website is not affiliated with any of the manufacturers or service providers discussed here.
All logos and trade names are the property of their respective owners.