Bounce back Loans (BBL's) have been a great mechanism during COVID-19 for businesses to get their hands on cash quickly and with little red tape. Their presence means that a lot of businesses will be able to trade comfortably for the next few months
However, there is a trap waiting for Directors if they aren't careful
Directors may be thinking of using the loans to pay themselves whilst there isn't much (if any) revenue coming into the business and that could be a very bad idea!
Most Directors pay themselves a low salary and take the remainder of the earnings through dividends. The issue here is that dividends are actually a distribution of profits after your corporation tax has been paid
If trading has massively reduced or even ceased, the liklehood of the business making profit during this period is slim, even non-existant. If you continue to take dividends, you may find that at the end of the financial year, you don't have enough profit to cover them.
This would potentially be a disaster!
If the company doesn't have enough profit to pay dividends, it's likely that those drawings would need to be reclassified as a Directors Loan. HMRC have some very strict rules around businesses loaning money to Directors. So much so, that they apply a tax charge of 32.5% of the loan amount to any loans still outstanding more than 9 months after the company's year end....OUCH!
This tax is repayable, once the loan is repaid to the company, but it's still not a great feeling to have to pay it in the first place.
So be careful!
What Can I do to make sure this doesn't happen to me
There are a number of circumstances where this won't be a disaster for you or your company.......
- It's possible that you've made more profits in previous years than you've drawn in dividends and therefore have reserves. You can tell if you do by looking at your balance sheet and at the bottom looking for the capital & reserves section. That will give you a profit and loss figure that has been brought forward from previous years. You can use that reserve to pay this years dividends
- You may have made good profits before lockdown and not drawn them all. You'll be able to use those now
- You believe that you'll make good profits very soon after lockdown is lifted that you can make dividend payments from to cover the loan you are taking now
If you have management accounts, you'll be able to keep a close eye on the relationship between the profit you're making and the dividends you are taking. If not, regularly check your Profit & Loss report in your accounting system (Xero makes this easy!). That will give you a good indication of your current levels of profit
I recorded a video to explain this in more depth. You can watch the video here
Above all, stay vigilant and on top of your profit levels to make sure you don't fall into this expensive trap!
If you'd like to discuss how this may impact you, please get in touch, using the link below