Dividends and the Director’s Loan Account are essential topics for any business owner who operates through a limited company. Firstly, dividends represent payments made to shareholders from a company's post-tax profits. Unlike wages, dividends do not attract National Insurance contributions. Consequently, they are a tax-efficient way to reward shareholders. However, dividends can only be issued if the company has sufficient profits and positive reserves. Proper documentation, such as board meeting minutes and dividend vouchers, is a legal requirement.

Introducing the Director's Loan Account (DLA)

A Director's Loan Account (DLA) serves as a vital record within a company's financial framework, meticulously documenting the intricate financial interplay between the company and its directors. Essentially, it functions as a ledger, meticulously tracking all financial transactions that transpire between these two entities. This encompasses a spectrum of activities, including instances where directors generously contribute their personal funds to bolster the company's resources, or when they personally shoulder company expenses. In such scenarios, the DLA faithfully reflects these contributions as credits, acknowledging the director's investment in the company's well-being. Conversely, when directors withdraw funds from the company, receive reimbursements for company-related expenses, or draw a salary, these transactions are duly recorded as debits within the DLA, providing a transparent and accurate accounting of the director's financial interactions with the company.

Link Between Dividends and DLA

The connection between dividends and the DLA is noteworthy. Whenever a DLA becomes overdrawn—i.e., the director owes money to the company—it may result in tax consequences. Accordingly, dividends are often used to clear these overdrawn balances, provided there are sufficient profits. Nonetheless, ensuring compliance with the Companies Act is vital to avoid penalties.

Key Considerations

Altogether, understanding these financial tools is vital for effective business management. Equally important is maintaining proper records and seeking professional advice. Notwithstanding the complexities, staying informed ensures you remain compliant while maximising benefits.

Final Thoughts

Lastly, dividends and the Director’s Loan Account are significant aspects of running a limited company. Therefore, staying aware of your legal and financial responsibilities is essential. For more insights and practical advice, listen to the I Hate Numbers podcast today and take charge of your business finances!

Many people would have come across the term dividends, heard it taught by other people, by commentators. They may have had that term mentioned by their accountants if they're in business. Well, in today's podcast, I'm going to be looking particularly at dividends with specific reference as to what they actually are, how you can legally pay them to yourself,

and thirdly, we're going to mention something called the director's loan account, or DLA for sake of abbreviation.

A few things just to emphasise and clarify before we progress with this podcast is number one, if you have a company, so it will normally have the letters LTD at the end of it, or limited in full, that's a company, not sole trader. So if you have a company and you happen to own that company in part or in full, so you have what are called shares of that company, then you are classified as a shareholder.

If you happen to also be the person that runs that company, taking the day-to-day decisions, then you are also the company director. The idea of dividends is only applicable to those people who are shareholders in companies. For most small businesses, the people who represent the shareholders, the investors, if you wish, also happen to be the company directors.

Now, dividends are normally touted and talked about as a tax-efficient way, question mark, to take money and extract it out of your business. Now, this podcast is not going to be focusing on tax numbers, tax rules, when it's advantageous, and all the rest of it. That's for another podcast. It's been dealt with historically, but we're going to come back and revisit that later on.

But it's looking at the rules, the responsibilities, what you should do, what you shouldn't do, what dividends are in general terms, and how you go about making those dividends, and not to forget the wonderful DLA. Not to be confused with DVLA, which is something completely different, and it's to do with driving and cars.

Now dividends, firstly, are payments made by a company to its shareholders. Typically, it's a financial transfer out of the company into an individual's bank account. It can be made at one point in time. It can be declared as it's called and made in the future. But dividends are only payable to shareholders, and it is a very popular way to extract funds from the business.

Now there are some critical things to understand here. Firstly, there's a legal role. And dividends can only be paid from your company's post-tax profits. So if you imagine you're running a company, that company is a creative agency, and it's invoicing clients for work it's carrying out. It deducts its ongoing expenses, typically like advertising, software, fees to the accountant, let's not forget them.

It then has a profit that it's made, and then it's got to pay tax on that figure. It's the money left over after paying all the running costs of the business, the expenses, if you want, and the corporation tax, whatever's left over is called post-tax profits. Now, it's critical that your company has got post-tax profits built up, either for that year in question to constitute what are called reserves.

If you don't have positive reserves, by the way, it's illegal to make a dividend payment. You won't go to prison, by the way, but there will be potentially a financial consequence. Also worth noting, dividends are not considered to be business costs. So they're neither your salary, which will be dealt with under what's called PAYE, and they're neither expenses, business expenses from the company.

So if you pay yourself a dividend of, say 5 000, that does not reduce the profit that will be subject to corporation tax. Dividends are not classed as wages, they are considered, if you're on a posh term, appropriations of profit. What that means also, is there's no national insurance contributions payable on those dividend payments.

That potentially attracts some tax efficiency, but obviously the downside is that you're not going to get tax relief from those dividends, so that could also be a downside. Lastly, dividends, even though a lot of people may not necessarily follow this formality, have to be formally declared by the company directors, not the shareholders.

It's to the directors that make that decision. So if you happen to be the shareholder and sole director of your company, technically speaking, you're wearing two hats. Hat number one is the director of that company that makes that decision of how much of the profits remaining in the company are to be paid out as dividends, either now or at some point in the future.

And also there's the requisite paperwork you must complete as well. Now let's talk about the director's loan account. Now, in your capacity as a director of your company or one of the directors of the company, it’s likely that during the course of time, money will be transferred out of that company into your own personal account, and it's likely that money will be put into the company by yourself as well.

Now, imagine your director's loan account is like a seesaw. On one side of the seesaw is where the company, considered to be a separate legal entity from you, owes money to you. So typically, if you're running a payroll, you're paying yourself under PAYE, which stands for Pay As You Earn. Each month that goes by, you'll be entitled to a net salary.

Let's say for argument's sake that it's worked out that for you it's advantageous to set a salary which gives you a take-home pay of a thousand pounds per month. That's what the company owes to you. That's effectively your take-home pay, and that will mean your director's loan account is in credit because that's money the company owes to you.

If you've also had to put funds into the company at any point, maybe because you're running short of cash, maybe you're just getting the company started, or maybe there's funding that needs to be provided by yourself. When you put money into the company, the company owes it to you, that also counts as a credit on your loan account.

If you pay for things like travel expenses, items purchased on behalf of the business, and you're using your own personal debit card, or your own personal cash, your own personal credit card, then effectively, you're incurring that expense on behalf of the company, and the company owes that to you. And ideally, that should be recorded within your digital accounting system.

You can use spreadsheets and other things, but let's go digital, and let's do this thing properly. Now on the other side, money is going to be withdrawn from the company. It may be withdrawn to pay yourself the salary that's owed to you, it may be taken out to reimburse yourself some of the expenses, or it may be taken out to partly pay or fully pay the money you've put in personally.

Most likely, you might also take out more money than you're entitled to. So we come back to that see-saw effect. During the course of the year, you extract 10,000 pounds out of the business that goes into your personal account, and it works out, the company owes you 5 grand for reimbursed expenses and potentially

funds you put to the company and potentially some that also could be from PAYE salary. Now if the company owes you five and you take out ten, you've taken up more than you're legally entitled to. And that gives you what's called an overdrawn loan account. Now you have two choices, you either leave the loan account as overdrawn.

When it comes to your company's year-end, if that loan account is still overdrawn in what accountants call a debit balance, then the company will pay what's called advanced corporation tax on that. And that could be quite an eye-watering number. What normally happens is that loan, once the formalities are done, will be written off, a dividend will be declared to clear that loan account down, and that loan account then becomes your dividend for the period of time.

Now obviously we have to make sure there's enough profits to justify that conversion of that overdrawn loan account into a dividend, but assuming that is happening, then that's perfectly fine. Now, technically speaking, let's be technical because if you run a company, you're governed by the Company's Act, amongst other things.

And the timing here is crucial. Technically speaking, if you take money out before formally declaring a dividend, HMRC could, in theory, if they discovered this, see it as a way that you avoid tax. That formality of having to do the documentation to support that dividend is, technically speaking, an essential requirement for a company, albeit

many small businesses may not do that either because they aren't aware they have to do that or because they don't have the resources or because they've not received the right advice. In next week's podcast, by the way, I'm going to be looking at the paperwork in a lot more detail. So what can we conclude?

Well, dividends and the loan account are inexorably linked. Dividends allow you to extract profits efficiently, but they have to come from post-tax earnings. I should have added also, by the way, folks, that you need to make sure you've got the cash if you're going to pay dividends beyond your overdrawn loan account. The loan account itself, just think of it as a way that it tracks the money that you take out as a director and the money that is owed to you for things like expenses, salaries, and funds injected.

I hope you found this useful, and I'd love it if you could share with those who you feel will benefit. In next week's podcast, we're going to get down and dirty and have a look at some of the accompanying paperwork, which is a recommendation to complete in order for you to stay compliant and for you to rest easy.

Until next week, happy dividends. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.