Being A Shareholder
Robert Browning is a chartered accountant formerly in public practice, with many years' experience of advising small businesses. He is based in Ware, Herts.
One of the first things that anyone starting a company wants to know is how do they get payment out of the business for their own labours.
If you are a sole trader or are in partnership you can in theory just take the money when you want to. This is commonly known as drawings as you are drawing out money on account of profits that you hope will be made. The tax on these ‘earnings’ is paid later when the profit figures are known.
In a company things are different. As the company is a separate entity it has to pay you either:
- as an employee by means of a wage, a salary or by commission, or
- as a shareholder by way of dividend.
Let us consider the implications of each of these in turn.
Payment by wage, salary or commission
A company is required to pay all employees, and that includes directors and the company secretary, assuming they are paid at all, under the PA YE system so that tax is deducted directly at the time of payment. Paying your taxes is discussed further in Chapter 10 but suffice to say if you intend to pay yourself from your company you will have to do it in accordance with the rules that apply to all employees.
You will therefore have to decide how much money your company can afford to pay you and treat that as a wage or salary on a regular basis. Subsequently, you may find that you are taking too much which either starves the company of cash resources needed for the business or means that the company is just not making enough profit. You will then have to waive your salary for a while till business picks up. What you must not do, in these circumstances, is just draw money out as you would as a sole trader or partnership. The reason for this is simple. The company is a separate entity so if you just draw money out the company is, in effect, lending you money.
This may seem harsh because there is a tendency to think of the money in your company as your own but it is not. It belongs to the company. And the company, like people, has to pay its tax. It is known as corporation tax and the rate is fixed each year by the Government in the Budget proposals. For small companies it is normally a similar rate to the standard rate of income tax. From July 1999 companies are required to assess their own profits on a similar system to the rules applying to income tax.
Case study: Hannah and Usha decide on equal salaries
Hannah and Usha have decided to pay themselves a small salary whilst the business builds up. They contact the Inland Revenue to ask what they should do and receive in return a package of information described as a New Employers Starter Pack. This contains all the forms and instructions for taxing wages and salaries under the PAYE system and accounting for their national insurance contributions. As they only want to pay themselves as directors and have no other employees they read the information carefully to see what is required. They realise their tax has to be paid each month.
Payment by dividend
The profits of a company can be distributed to the shareholders by way of dividend. This means the company decides to pay out so much per share and all shareholders will participate. This may prove difficult if all you are trying to do is pay yourself.
Your company pays a dividend to its shareholders on 31st December. There are 1000 shares in issue and you and your directors declare a dividend of £2 per share. The company will pay corporation tax on the profits and your shareholders will receive, in respect of each share they hold, £2. The cost to the company is greater by the amount of the tax paid but shareholders will get a tax credit for each share in respect of the corporation tax paid, meaning that the tax is already paid on this income when they receive it, and no more tax at the basic rate is payable by them. They could, however, pay income tax at a higher rate if their overall income is high enough.
There is more information on corporation tax in Chapter 10.
There is a further way of paying yourself in a company which should be mentioned. Fringe benefits are where the company pays money on your behalf for certain services. The most common fringe benefit is the provision of a company car. The amount upon which tax is payable is a percentage of the list price of the car inclusive of accessories, delivery charges and VAT, but the percentage is reduced depending on the age of the car and the business miles covered. Also note that companies have to pay national insurance on the taxable value of an employee’s company car. Other benefits you might enjoy include meals in a canteen provided all employees are entitled to them or the cost of an insurance premium which would pay you if you were unable to work.
Additionally benefits are treated just as if you had earned the money and you are taxed at the rate applicable to your salary plus your benefits less anything you contribute to them. However, this applies only if that figure is £8,500 or more or if you are a director.
Minimising your tax bill
The way you pay yourself is crucial when you are trying to minimise your tax bill. Ideally you will pay yourself the amount at which the tax rate is equal or lower than the tax rate on the company’s profits. Anything above that will attract the higher rate of income tax and that is higher than the small companies corporation tax rate.
The decision of what to pay yourself is complicated and you would do well to take advice from your accountant before you start. However, in the end you will pay yourself what you need for your standard of living or what the company can afford. And you will personally have to bear the tax on that figure.
USING YOUR VOTING POWER
You saw in Chapter 3 that votes are taken, where necessary, at formal meetings of the company and each shareholder has a vote for each share owned. If, therefore, you hold a majority of the shares you will get a majority of the votes and this will enable you to carry out any changes or policy decisions you wish to.
If, however, you only hold 40 per cent of the shares there are potentially 60 per cent against you. It is rare in small companies to have such disagreements and probable that, if it were the case, the problem is fundamental and another course of action will be required to resolve it.
In most small companies the only formal decisions to take are at the annual general meeting and those normally involve:
- receiving the report of the directors
- adoption of the accounts for the previous financial year
- re-election of certain directors if the articles require them to stand down
- election or re-election of the auditor (if the company has one).
You would be well advised to think carefully how your shares are distributed amongst the shareholders, as most decisions are put to a normal majority vote.
Case study: Harry sets the charges
Harry’s company was beginning to incur expense in maintaining gardens at the flats and he thought he would charge the tenants on a pro rata basis for their shares of the expense. Although they had agreed at the first meeting not to hold another one before the flats were sold he uses his prerogative to summon a meeting to put his resolution that a charge should be made. Although the other shareholders object, albeit with tongue in cheek as they realise the jobs must be done, Harry uses the power of his nine shares to push the resolution through. All the tenants from now on will pay fixed maintenance charges.
EXERCISING YOUR RIGHTS
You will not normally be required to exercise most of your rights as a shareholder in a small company. These are put in place by the various Companies Acts and by the provisions of the Memorandum and Articles to deal with intractable problems you may encounter as a shareholder. Should you be involved in a difficult area of company law you must seek advice from a lawyer or accountant as there are precedents (ie similar cases that have happened before) for a number of things which can occur.
Knowing what your rights are
There are certain rights that you will be involved in on a regular basis. As a shareholder you are entitled to:
- receive proper notice of any meeting of the company together with copies of any proposed resolutions so that you can attend and vote on them
- receive the financial accounts of the company for the preceding year
- transfer your shares to someone else by agreeing the price with the directors; it is often usual, according to the Articles, for these shares to be offered to the remaining shareholders in the same proportion that they hold their existing shares so that their voting rights do not alter
- call an extraordinary general meeting of the company
- be involved in any reconstruction of the way the company is financed, the sale of the company or its amalgamation with another company
- concur in the modification or variation of any rights, privileges or liabilities attached to the shares.
It is to be hoped that your company will be well run and any difficulties cleared before you need to exercise your rights. But there must be provision for the unexpected or unforeseen.
Earlier in this chapter we saw how shareholders could be paid by dividend and the consequent tax implications. Directors recommend dividends. This is done by taking into account the financial position of the company at that time.
Types of dividend
There are two types of dividend:
Interim dividends can be declared by the directors at any time and a meeting of shareholders is not required to sanction this. The final dividend is agreed by the shareholders at a general meeting when they will also formally agree any interim dividend previously paid. In the absence of any provision to the contrary in the Articles dividends must always be paid in cash. They must also be paid out of profits.
An equal amount is paid for each share owned but in some companies there can be different classes of shares.
A company is set up with two classes of shares:
1. preference shares
2. ordinary shares.
Preference shares are entitled to a dividend before ordinary shares are. It is usually at a fixed rate and is payable whether the company is doing well or not. Holders of preference shares have put money into the company as a fairly safe investment with a small return of interest. Ordinary shares are much more linked to the fortunes of the company and dividends can vary a lot. Sometimes no dividends are paid at all.
It is probably fair to say that in the majority of small companies payment of dividends is rare as profits are invariably taken as director’s salary or other fringe benefits.
LIMITING YOUR LIABILITY
Small companies are in the main set up for one reason, and one reason alone, and that is to limit the financial liability of the shareholders to the amount of the nominal value of the shares they have purchased.
With no limited liability all of a person’s assets, including his house, are available to his creditors (the people he owes money to). A limited company, which is a separate legal entity from its individual shareholders and directors, has its own assets and liabilities. But these are nothing to do with the directors or the shareholders personally and hence their liability for the company’s financial debts and responsibilities is limited. Unless, of course, the directors have been trading fraudulently.
That all seems fine. But beware.
Other businesses have become aware that unscrupulous businessmen have taken advantage of this limited liability and run off with the company money or assets. Also when you are embarking on a new business venture you have to build up your credibility before you are fully trusted. Therefore you may be asked for personal guarantees against your business debts. Note that:
- banks, in particular, will ask for guarantees for an overdraft facility or a loan
- this can also apply to leasing agreements
- landlords may also consider this in respect of rent
- even normal suppliers may insist on it for normal credit arrangements.
Once any of them do this your limited liability is severely impaired. Do not think that limited liability removes all your business worries. It can sometimes make them more of a headache.
Dean wants an overdraft
Dean now has to stock up from his suppliers and they are being very helpful. After all Dean will be selling their products to his customers. However, there is a lead time between his sale to his customers and them paying. So Dean went to see his bank manager. He had prepared himself for this meeting by forecasting his expected sales and expenses and the amounts he would pay for stock. The bank manager agreed to let him have a small overdraft facility to cover this money shortfall but only on two conditions. Firstly that he prepared a cash flow chart to see where his predictions would produce the greatest shortfall and secondly that he gave a personal guarantee to repay the bank from his own resources if the company could not pay. So much for his limited liability.
ACTION POINTS AND REMINDERS
- 1.Decide how much to pay yourself but don’t overdo it.
- 2.How will you pay your tax? It is due each month.
- 3.See your accountant about paying dividends and make sure it is necessary.
- 4.If you are having a company owned car you must keep adequate and accurate records of the expense.
- 5.Make sure you own the majority of the shares.
- 6.You may have to give someone dealing with your company a personal guarantee so be prepared.