Before we examine this issue from a tax perspective we need to emphasise the difference between limited companies and sole trader and partnership businesses in the way that they distribute taxed profits to the business owners.

Sole traders and partnerships are taxed under the self assessment rules. Profits are allocated as agreed by the business owners and tax is calculated on an individual basis based on this profit share. If sole traders or partners withdraw the retained profit after tax this is treated as drawings and not a business expense.

It is possible for sole traders and partners to draw out more than the balance on their current account, to become overdrawn, and suffer no tax consequence. Of course there is no long term future in doing this as funds needed for the business, will be dissipated and the business will drift towards insolvency. Businesses of this type pay tax on business profits, not the amount taken out of the business by the owners.

Limited companies and their owner directors are treated very differently. A limited company has a distinct legal identity of its own, quite separate from its shareholders/directors. Money that is withdrawn by the owners, in whatever way, always has a tax and possibly National Insurance consequence except as a repayment as a loan from a director.

Essentially money withdrawn by directors will be treated as:

  • salaried earnings or benefits, and/or
  • dividends

So if you pay your private bills through a limited company what happens?

If you already have money invested in your company that has been credited to a director’s loan account in your name, then the payment of a private bill can be debited to this account, reducing the amount the company owes you. In this case there is no tax consequence.

If you do not have money invested in your company in this way, any private payments you make will create an overdrawn balance on your director’s loan – you will owe the company money. Now there are tax consequences.

If your loan account does become overdrawn the following options and tax effects are available to you.

  1. You repay the overdrawn balance. If this is done as soon as the payments are made there should be no tax to pay.
  2. The company writes off the loan. The balance written off will be treated as your earnings subject to PAYE and National Insurance, or in certain circumstances, as a dividend.
  3. The director’s loan remains unpaid. A benefit in kind charge will be created equal to a statutory rate of interest for the time the loan is overdrawn in a particular tax year. This benefit can be avoided if the company charges your loan account with an equivalent interest charge. Unpaid director’s loans can also create an additional corporation tax charge if the loan remains unpaid more than nine months after the company’s year end. This extra tax can be reclaimed by the company when the loan is subsequently repaid, but there will be a delay.

Action point
If you need to overdraw your loan with the company it is better to plan for the tax consequences and perhaps find a more suitable way to extract funds from the company. Please call if you would like more information on this topic.