PROFIT EXTRACTION - 17.04.2024

Can dividends ever be paid from loss-making company?

Income or profit extraction

As a company owner manager, the usual tax planning advice you’ll receive is to take a modest salary and the remainder of your income needs as a dividend (also referred to as a distribution). This is generally good advice but it’s not always possible to follow it.

When a dividend can’t be paid

Company law only allows dividends and other distributions to be paid to shareholders when the company has reserves, i.e. accumulated profit. If your company has a bad run and makes losses these will eat into its reserves and limit its ability to pay a dividend or prevent it entirely. If you need cash income from your company, but it can’t be a dividend, the only alternative is salary; but this comes with hefty extra tax and NI costs.

Example part 1. Dev’s only income is derived from his company. Normally, he draws a salary equal to the tax-free allowance (£12,570 for 2024/25) and a further £50,000 in dividends. However, after a couple of poor trading years his company has no reserves from which to pay a dividend. He therefore takes an additional salary of £50,000 instead. After tax and NI contributions this leaves him with net pay of £33,770. Had he been able to take a £50,000 dividend, the net of tax amount (there’s no NI on dividends) would be £42,550. Taking salary leaves him nearly £9,000 worse off (see The next step ).

Tax-efficient alternative

Rather than all cash salary Dev’s company, Acom Ltd, might be able to enter into arrangements whereby it was billed for services or goods which Dev would normally settle personally. Such arrangements would count as taxable benefits in kind. This would save Dev NI equal to up to 8% of the value of the bills that the company settled. That’s helpful, but in practice there’s limited scope for such arrangements as Dev will need cash to pay his mortgage and other debts that can’t be transferred to his company.

Tip. Company share capital can be converted into reserves which can then be paid as dividends.

Example part 2. Dev started Acom with £120,000 in exchange for 100 ordinary £1 shares. For accounting purposes £100 is recorded as share capital and the balance of £119,900 as a share premium, i.e. the amount given in excess of the share par value. Because of trading losses Acom’s latest accounts show its reserves as a negative £25,000. However, company law allows all or part of the share premium to be repaid, as long as the company remains solvent (see The next step ). The amount repaid can be credited to the company’s profit and loss account. Acom repays £75,000 of the share premium which when credited to its profit and loss account changes the negative £25,000 reserves to a positive £50,000 which allows Acom to pay Dev a dividend.

For the calculations behind the example and details of the procedure for repaying share capital, visit https://www.tips-and-advice.co.uk , Download Zone, year 24 issue 14.