Extracting funds from a family company without retained profits
Many family companies have struggled as a result of the COVID-19 pandemic and may no longer have any retained profits. Where this is the case, they may need to rethink how they extract funds from their company to meet their personal bills.
A popular and tax-efficient strategy is to pay family members a salary equal to the primary threshold, set at £9,500 for 2020/21, or, if the employment allowance is available, a salary equal to the personal allowance of £12,500, and to extract further profits as dividends.
Requirement to pay dividends from retained profits
Under company law, dividends can only be paid from retained profits. This means that if a company lacks sufficient retained profits to pay a proposed dividend, they will not be able to pay that dividend legally. The ability to pay a dividend is constrained by the available retained profits.
Dividends must also be paid in proportion to shareholdings; however, the use of an alphabet share structure can provide flexibility.
Despite not having any retained profits, your company may have money in the bank. This may provide options for taking funds from the company where dividends are not an option.
Unlike dividends, salaries and bonus payments can be made where the company lacks profits, even if this results in a loss. Funds can also be extracted in the form of benefits in kind or, if the business is run from home, rent.
This will not always be ideal, from a tax perspective, but may be necessary. However, the directors must be wary of inadvertently trading while insolvent.
The company could also consider making a loan to the director. This can be a useful short-term option and it is possible for a director to borrow up to £10,000 for up to 21 months tax-free. However, there will be tax implications if the loan remains outstanding nine months and one day after the end of the accounting period in which it was made.
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We can discuss ways to navigate the COVID-19 pandemic and extract funds from an unprofitable family company.