Dividends and the Directors Loan Account

If you trade through a limited company, it is fairly likely that you will need to take money out of the company for your own personal use.  However, the methods for doing this can be confusing, and is almost always discussed when I have meetings with directors of new limited companies.

In addition to salaries, the two main options for taking money out of a limited company are dividends and loans, which are broadly defined as follows:

• Loans are monies taken from the company for personal use, often on a regular basis.
• Dividends are declared by the directors of the company to reward shareholders, and must have paperwork to support.  However, they can only be declared from ‘retained reserves’.

The term ‘retained reserves’ means accumulated post tax profits.  In other words, profits after tax.  If, for example, ABC Limited makes a pre tax profit of £30,000 in its first year, then 20%, or £6,000, corporation tax needs taking off which leaves post tax profits of £24,000.  This effectively means that ABC Limited can declare a dividend of £24,000.

However, the director of ABC Limited may need £2,000 on a monthly basis to pay his personal household expenditure.  He may not be able to wait until the end of the year to declare dividends.  So what can he do?  He has a couple of options:

• Declare a dividend of £2,000 each month.  The downside with this approach is showing that the company made a profit of £2,000 each month to support the dividend.  Profits often fluctuate from month to month.
• Take a loan of £2,000 each month from the company, which will be posted to the directors loan account.  The amount owed to the company will then build up, and can be cleared by declaring a dividend on a periodic basis, such as quarterly, bi-annually or annually.

You may realise that there’s a certain amount of risk with the second approach, as there is no guarantee that the company will make the profits to declare a dividend to clear the loan off.  Therefore, it is very important that loans are kept to a minimum, particularly in the first year.  It is essential that money is retained within the company for the corporation tax bill (which should be 20% of taxable profits).  The consequences of having an overdrawn directors loan account can be quite serious, so care needs to be taken to get it right.

We manage dividends for the majority of our limited company clients, even putting the paperwork together.  If this is a service you wish to discuss, please do not hesitate to get in touch.