Blog: Trouble ahead for company directors who refuse to separate their business and personal finances
Launching a new business venture can produce a multitude of feelings: excitement, fear of the unknown, nerves and anticipation. But the one emotion that undoubtedly binds everyone going solo with their own company is one of being overwhelmed.
Most people are driven to start out on their own due to a personal passion for a product or service or because they see a gap in the market that can be commercially exploited. They have all the knowledge of their own particular field of expertise at their fingertips, but suddenly they find themselves wearing many different hats – and not all of them are a comfortable fit.
Andrew Bell, corporate tax manager at Aberdeen independent chartered accountants Hall Morrice, says that it is not unusual for new entrepreneurs to find it difficult to separate their personal life from a venture they may have spent months or even years planning.
In many cases, the most difficult area for them to separate tends to be financial.
Mr Bell explains: “Many new start-ups - and it has to be said many businesses that have been operating for years too - are so focused on doing what they do to deliver their service that they do not always take the time to understand the wider commitments of running a business, particularly on the financial side.
“Running a limited company is not like operating a business as a sole trader or partnership whereby the proprietor can make drawings from the accounts. A limited company is a separate legal entity and the financial side of the business must be treated with expert care.
“Time and time again, we see business owners making the same mistakes, not through any kind of deliberate malice, but through a genuine lack of understanding of what is and what is not appropriate.”
Mr Bell says that the majority of errors fall into two distinct areas: confusion over what can be considered a legitimate business expense, and a false impression that business accounts can be used as a company director’s personal account.
It’s simply not appropriate, explains Andrew, to take money from the business account to pay for items that are not required or used by the company. Failure to comprehend this can cause a nightmare scenario for accountants when completing accounts and submitting tax returns.
The simple rule is this: the company account is for company things only. It should only be used to withdraw salaries, legitimate company expenses and dividends. It’s not there to fund family holidays, pay for new household goods or nights out with friends.
Mr Bell said: “The number of businesses that treat the company cheque book as their own is much higher than one would think. Some company directors seem to think that just about anything can be signed off as a business expense – they do not recognise that the company is its own entity and it is not a private cheque book.
“The rules, however, are very strict and it will be immediately obvious to an accountant what can and cannot be classed as legitimate businesses expenses. We spend a huge amount of time working with clients to explain this and keep them on the right tracks.”
These are the three most common mistakes that Andrew encounters when businesses try to offset expenses against corporation tax:
Company entertaining – generally as long as it is considered a staff event, such as a Christmas party, the cost is tax deductible. The absolute limit, however, £150 per head and not a penny more. The guests must be staff, so be sensible – don’t invite a group of friends or even clients as their presence there is not for business purposes and the costs therefore are disallowable.
Business trips – it’s entirely acceptable for a company bank account to be used to pay for the costs of a company director attending a trade show in London for the weekend. What would not be acceptable, however, would be for the company accounts to be used to pay for the costs of the director’s wife accompanying him if her presence has no connection to the business dealings of the company.
Dual expenses – sometimes the lines between business and personal expenses do cross over. As long as there is a clearly identifiable portion of an expense that can be identified for the business, it is possible to claim that as an allowable expense. A good example of this would be a claiming a percentage of household utility bills for those working from a home office. If there is no way of clearly separating the two, then there is no claim. For example, it is not possible to claim for a new three-piece work suit as HMRC would consider this as part of an everyday wardrobe.
Mr Bell says the lack of understanding on expense issues not only results in accountants having to spend additional time resolving them - it could have much more serious implications.
He added: “Company directors have legal responsibilities to manage the company funds for commercial operations. It is not just about a title or a flashy business card: Companies House has very strict rules and regulations and there must be accountability.
“If any money is taken from the company that is not a salary, dividend or legitimate business expense repayment, this is considered a director’s loan withdrawal. These withdrawals build up in what’s known as a director’s loan account.
“A director is not allowed to be a debtor to the company, and the loan account needs to paid back and returned to zero. If as a shareholder and director you owe the company money, then it is likely that you and your company will have to pay tax on the loan.
“It is an unnecessary expense which can be completely avoided by directors not using the company cheque book for their own expenses. The key point to bear in mind that personal bank accounts are for personal use; business bank accounts are there to be used only by the business.”
Founded in 1976, Hall Morrice Cahrtered Accoutants has offices in Aberdeen and Fraserburgh.