It can sometimes be tax efficient to charge your company interest for
balances owed to you on the director's current account, particularly if
there is a high level of retained profits. Dividends can be declared early
in the tax year out of retained profits and be used to fund cash
withdrawals throughout the year, meaning there is always a balance
owing to you. You can charge your company a reasonably high rate of
interest for this, for example base rate + 4%, and the company would
be able to claim a deduction for this against corporation tax.
The real advantage to you of doing this is if you have no other income
apart from a low salary and a dividend just high enough to use up your
basic rate band. Personal allowances are now higher than the National
Insurance earnings threshold, so if you set your salary just high
enough to keep up your NI record but low enough not to actually pay
any NI, part of your personal allowance will be unused and available
for offsetting against the interest you receive from the company.
Therefore it will be tax free.
Also, the 10% band infamously scrapped by Gordon Brown in 2007
does in fact still exist, but only for savings income. The threshold is
£2,440 for 2009/10 which is more than enough at current low rates to
absorb interest received from your company. Unfortunately, interest
always comes after earned income in the queue to be taxed, so most
people never actually benefit from the 10% band. However, by keeping your salary low you can preserve the 10% band for savings income.
Therefore, you pay 10% but the company saves 21% on the same
income.
For example, your company has retained profits of £30,000 and you
declare a dividend for this amount on 6 th April. You don't need to take
the dividend yet so it sits on your loan account, which is already
£10,000 in credit from the previous year. You make a monthly
withdrawal of £2,500 so by the end of the tax year you have claimed
the full dividend. The average balance on your loan account
throughout the year is £25,000. At 5% this earns interest of £1,250. If
you take a salary of £5,720 and your personal allowance is £6,475 this
leaves a balance of £755. Therefore, the first £755 of interest will be
tax free in your hands and the balance of £495 will only be taxed at
10%. Meanwhile, your company will save corporation tax of £262.50 so
overall you will be £213 better off.
Small beer at this level of income, but if you have not taken all the
dividends owing to you from previous years the balance on your loan
account could be much higher. If interest rates go up, that could be
worth a lot more. If you did manage to use up the whole 10% band,
you would save an additional £213.95, making £426.95 altogether. Not
a huge sum but a nice little earner and more than the banks would pay!
However, don't forget to declare it on your tax return, and you also
need to mention it in your Accounts under Transactions with Directors.
