A contractor’s guide to bounce back loans, dividends and illegal dividends

New to contracting? We explain what dividends are

If you’ve been contracting for a while you may wish to skip this first section, but if you’re just starting your contracting career or are considering taking the leap, you may be wondering exactly what a dividend is.

If you have profit in your Limited Company, you’re able to draw payments to your company’s shareholder/s in the form of dividends. To be able to do so you’ll have to make sure you hold a director’s meeting whereby you’ll need to declare the dividend, keep minutes of the meeting (even if you’re the only director), and include a dividend voucher, which is paperwork detailing the date, who received it, the company’s name, and the dividend amount.

As your company won’t pay tax on dividends less than £2,000 in value, many directors decide to use a combination of a low salary and dividends, in order to keep their monthly take home pay as high as possible whilst remaining tax compliant. Dividends that that you do draw are taxed as personal income, and the following % thresholds are applied over the £2,000 limit:

Basic rate – (taxed at 7.5%) up to £50,000

Higher rate – (taxed at 32.5%) from £50,001 to £150,000

Additional rate – (taxed at 38.1%) £150,001 +

New contractors should discuss their salary and dividend plans with a specialist contractor accountant, to make sure everything is done correctly.

Bounce Back Loans

Throughout the pandemic you may have been tempted by the 2.5% Business Bounce Back Loan (BBL), but before you jump in, approach with caution! Whilst BBLs are not taxable when your company receives them, if your company draw the funds as dividends then you will have to pay income tax based on the rates above.

Why is this the case and what’s classed as an ‘illegal dividend’?

You’re able to draw dividends if there is post-tax profit in your company, or if your company has accumulated profits or reserves over previous years. If there aren’t sufficient funds to take a dividend then it is classed as an illegal dividend (also known as ultra vires). If you find yourself in this position before taking any action be sure to speak to your contractor accountant, to convert these into loans to keep the taxman happy. This makes the money a loan rather than a dividend, meaning you’ll need to pay it back to your company.

How do you know if there is enough money to draw a dividend?

Sadly it’s not as simple as logging into your company’s bank account and taking a look at your balance. Be sure to speak to your accountant who will be able to advise you on how much you’re able to pay yourself as a dividend, whilst ensuring there’s enough left to pay the taxes and other bills that are due, and therefore accidentally paying yourself an illegal dividend.

Bounce Back Loans – what’s the associated risk?

If you’re considering using a Bounce Back Loan (BBL) for personal use, approach with extreme caution! It’s clearly stated that a BBL is not to be used ‘for personal purposes’ which could include director’s loans. You must inform HMRC of any outstanding director’s loans at the end of your company’s accounting period.

32.5% Corporation Tax on loans – when can you expect this to take affect?

If you fail to repay a director’s loan from your company within the nine months and one day timescale, your company will be liable to pay the 32.5% ‘S455’ Corporation Tax bill. Whilst financially this could mean paying out a large sum at the time, once you’ve repaid the loan in full back to HMRC, you are able to claim back the 32.5%. We advise to only take out a loan that you’re confident you’re able to repay within the timescale, thus removing any possibility of having to pay the additional Corporation Tax.

What about personal tax on loans?

If you’re considering borrowing a director’s loan of more than £10,000 within one tax year, your loan will be classed by HMRC as a ‘Benefit in Kind (BiK). If you’re able to pay your company interest on the loan at HMRC’s official rate (2% from April 1 2021), you’ll avoid the extra personal tax implications, which will include a National Insurance charge for your company.

How’s best to stay on the safe side?

By paying yourself a salary you’ll know that you’ll always be paying the correct amount of tax, and therefore keeping on the right side of HMRC. If you’re considering a loan ask yourself if you’re confident that you’d be able to repay it personally, and if the answer is ‘no’ then stick to a salary and ask your accountant about your other possible options (if any).

Don’t forget that BBLs must never be used for personal use, and insolvency practitioners will not be likely to accept one should you draw dividends after receiving one. This is because by drawing a BLL you’ve demonstrated that there were no released profits in the company to draw any dividends from, and therefore this is classed as an illegal dividend. Do note that this also includes an increase in salary payments, as this could be considered as being used for personal use.

To try to aid politicians in dealing with the gaping hole in the BBL regime, some insolvency practitioners have said to some contractors that they will be acting on a commercial basis. Any contractors who fail to pay back what’s due may find that all standard methods of collection will apply, including the risk of bankruptcy and repossessing people’s houses.

Now is the time to speak to a specialist contractor accountant

If you have a specialist contractor accountant be sure to discuss any of the issues raised in this blog, as they will have an overview of your personal and professional needs along with your company’s account, and will be able to give you tailored advice that’s best suited to your needs.

If you’re either switching accountant or are new to contracting and shopping around, here at SG Accounting our goal is to provide you with the expert accounting services you expect, to help you bring home as much of your contractor pay as possible, and ensure you pay what’s due to the taxman, but not a penny more! With expert IR35 services, a direct line to your dedicated accountant and plus so much more, get in touch today to speak to our team.