What happens if you've taken too much money out of your business?

How can you take money out of a limited company?

Unlike a sole trader, the finances of a limited company and its owners are legally separate, so you’re unable to dip into the business’s funds at will. To take money out of your limited company legally, you must do so in the following ways:

Salary, expenses and benefits

The most tax-efficient way for company directors to pay themselves is to take a small salary that they supplement with dividend payments. Directors usually take a salary up to their personal income tax allowance. They can also claim expenses and bonus payments but must report them properly and pay the tax owed.

Dividends

Directors and shareholders can pay themselves dividends from the company’s retained profits. It is unlawful to pay a dividend if the business does not have sufficient profits and there can be serious consequences for the directors involved.

The amount you can take in dividends is determined by how many shares you have in the company. If you are the sole shareholder, you can take 100% of the profit as a dividend payment or leave some or all of the profit in your company.

When paying a dividend, you must hold a board meeting to get approval and record the meeting’s minutes. That helps to show the correct procedures were followed in the event of a challenge from HMRC.

Director’s loan

Any money you take out of the company that’s not a salary, dividend, expense or benefit is classed as a director’s loan. When you take more money from the company than you have paid in, the director’s loan account becomes overdrawn. All transactions in the director’s loan account must be properly recorded and included in the balance sheet and company tax return.

As long as you repay the overdrawn director’s loan account within nine months and one day of the end of the accounting period and the business is solvent, there shouldn’t be any complications or additional tax to pay.

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What if you declare a dividend that’s too high?

It’s not unusual for a company to declare a dividend that it’s not in a position to pay. Dividends can only be paid from profits, but in some cases, directors may declare a dividend only for the company to make less profit than expected at the end of the accounting period. Although this is not an ideal position to be, it can be rectified.

The payment can be treated as a director’s loan from the company. To avoid paying tax on the balance, the director must repay the loan within nine months and one day after the company’s year-end.

If you pay an unlawful dividend, it could be a simple mistake or a sign of more serious problems within the company. For example, it may indicate cash flow problems or be an early sign of insolvency.  

What happens if you pay a high salary or dividends the company cannot afford?

It may not make much business sense, but as long as your business can afford it and it doesn’t precipitate a decline, you can take as high a salary or dividend payment as you like. The problems come when you take more money out of the business when it’s struggling financially.

If the business subsequently enters a formal insolvency procedure such as Company Administration or Liquidation, an Insolvency Practitioner will investigate the directors’ conduct and the reasons for the business’s failure. If they find you paid unlawful dividends or took a salary the company could not afford, even if it was not the main reason the company failed, you could face serious consequences. That includes fines, personal liability for company debts and a director disqualification.

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How is an overdrawn director’s loan treated in insolvency?

Ordinarily, an overdrawn director’s loan account is not a problem if you repay it on time. However, it can become an issue when the company is struggling financially.

If the company becomes insolvent and you have not repaid an overdrawn director’s loan, the money you owe will be regarded as a company asset that the liquidator will seek to recover for the benefit of the creditors. If you do not make an agreement with the liquidator about how much you owe and repay the loan, they can pursue you through the courts to recover the amount.

That could put your personally held assets at risk and even lead to bankruptcy. You could also face other sanctions, such as being disqualified from acting as a director for up to 15 years.

What if you take money out of an insolvent company?

If you know your business is struggling, you might be tempted to recover some of the money you’ve put into the company over the years. However, if the company is insolvent i.e. it cannot pay its debts when they’re due or the value of its assets outweighs its liabilities, you must cease trading and retain all the company’s funds for the benefit of its creditors as a whole.

If you take money out of the business to repay yourself or a connected party, you are putting your interests ahead of the other creditors. This is known as a preferential payment. If the company subsequently fails and enters liquidation, the liquidator will look for examples of unlawful or wrongful trading, including preferential payments.

If they find evidence of a preferential payment, they can ask the court to reverse the transaction so the money can be returned to the company’s estate. You could also be fined, be made personally liable for company debts or be disqualified as a director.

Need advice?

If you’re worried you’ve taken too much money out of your company and it’s struggling financially, we can help. We’ll assess the finances of your company, explain your options and guide you on the best route forward. Please get in touch for a free consultation or arrange a meeting at one of our 100+ offices throughout the country.