Nichola Ross Martin's Tax Consultancy

HM Revenue & Customs (HMRC) do a toolkit for advisers but this is our version that includes planning points.

Overview

• It is not illegal for directors to borrow funds from their companies but this is subject to the 2006 Companies Act.
• Shareholder approval (by ordinary resolution, subject also to the provisions in the articles) is required for loans in excess of £10,000 (£50,000 if the loan is to meet expenditure on company business).
• A company should agree loan terms and document them accordingly.

An overdrawn director’s current account is a loan account

An overdrawn director’s current account that is not repaid can create various tax complications for both company and director.  

Taxable benefit: if the loan is interest-free and exceeds £5,000

• If the overdrawn (debit balance) on a director's current account with the company exceeds £5,000 it is trated as an employment related loan.
• A taxable benefit will arise on an employment-related loan if the employee does not pay interest to the employer at HMRC's official rate of interest.
• The cash benefit of the interest free loan for tax purposes is calculated by using an averaging method or on a daily basis. There may be a difference between the two methods and HMRC will use the daily basis where a loan balance fluctuates throughout the year.
• The cash benefit is the difference between interest calculated at HMRC’s official rate and the interest paid (if any has been charged).
  • The taxable benefit of interest calculated is required to be reported on form P11D.
  • A P11D dispensation cannot cover beneficial loan interest.
  • Class 1A NICs will be payable by the company on beneficial loan interest, which will also be required to complete form P11DX.
  • The director will be taxed on the benefit received.
• If a company does not write up its transactions contemporaneously it may be difficult for it to accurately determine when this type of benefit arises.

Tax charge on outstanding loans: section 455 CTA 2010

• When an overdrawn director's account is outstanding for more than 9 months after the company’s accounting period end, the company will be required to pay tax under s.455 CTA 2010.
  • S.455 tax is payable at 25% of the outstanding loan balance.
  • This tax is due 9 months and one day after the end of the accounting period in which the liability arises.
  • When the loan is repaid in full or in part s.455 tax is fully or proportionally repayable 9 months and one day after the end of the accounting period in which the repayment is made.
• Where a loan is repaid and then a similar sum advanced shortly after, HMRC may try to treat the loan as if it has been outstanding for the whole period.
• Where a director maintains a current account and also a loan account, the two balances may be kept separate and accounted for separately. It is advisable to agree this policy by way of a board minute.
• Two directors (typically spouses) may agree an offset so that one loan credit is set against the other's loan debit: HMRC will not accept the offset unless there is evidence to prove a joint loan account.
• If one individual has two loan accounts that are accounted for separately for reporting purposes and one is overdrawn HMRC may try to resist aggregating them for tax and so will not treat the two as one net balance.

Write off or release of an overdrawn director’s loan

When a close company writes off or releases a loan made to a director the amount is treated:

• Effectively as a dividend for Income Tax purposes (not also as earnings for tax purposes).
• As earnings for NICs purposes.
• The write off is an unallowable expense for Corporation Tax purposes.
• Class 1 NIC is tax deductible for the company.
• Under s458 CTA 2010, any s455 CTA 2010 tax is repaid to the company following the release or write off of the loan.

If the company has distributable reserves it will be preferable to declare a dividend and treat the loan as a contra paying the dividend in order to avoid a NICs charge.

Income Tax

• A loan that is released or written off will be treated as the taxable income of the director.
• If the write off is made in favour of a director who is a participator in a close company, and the company is or was chargeable to a s 455 CTA 2010 charge the amount written off is taxed as if it is a distribution under s 415 ITTOIA 2005. This means that the amount of the write off is treated as net income received after deduction of notional tax on the participator's tax return, but the tax credit is not repayable.
• If the company is not close, or the loan is not made to a participator, the write off will be treated as employment income under s188 ITEPA 2003, and should be grossed up for PAYE purposes and PAYE and NICs applied.
• If the write off occurs on the death of the director there is no tax charge.
• The s415 ITTOIA 2005 tax treatment takes priority over a s188 ITEPA 2003 employment income tax charge so there is no question of double taxation.

National Insurance Contributions (NICs)

• A loan released or written off is treated as earnings for NICs purposes if it constitutes remuneration or profit derived from an employment.
• A loan written off on death, is not treated as earnings.
• There may be other situations where a write off it not treated as employment related: expect HMRC to challenge these.
• A write off should be agreed by shareholders, rather than the directors, and if a company's solvency is in question, directors may wish to take legal advice before writing off loans.
• When the loan is subject to s415 ITTOIA 2005 the company will need to declare the write off and account for Class 1 NICs via its payroll.
• When the loan is treated as employment earnings under s188 ITEPA 2003 the company will need to gross up the write off through the payroll.
• For a detailed discussion see What are earnings for NICs purposes?

Corporation Tax

• S321A CTA 2009 (introduced in FA 2010) denies a close company Corporation Tax relief when it writes off a loan to a director.
• For accounting periods prior to 24 March 2010 it was in theory at least, possible to write off such a loan, however HMRC will challenge a write off if it considers that this amount is not wholly or exclusively incurred for the purposes of the business (s34 ITTOIA 2005)

Credits to a director's loan account

Bookkeeping is a major problem for some directors. Credits to a director's loan account are often made as accounting adjustments following the period-end.

• Ensure that there are no timing differences between the date a dividend or salary is voted and the date credited to the loan account, see implications in Taxable benefit: if the loan is interest-free and exceeds £5,000, above.
• If a director is using a company as a personal bank account review the loan account on a regular (that could be weekly or monthly) basis.

Also check that:

• Dividends are lawful and have been paid out of distributable profits, see Unlawful, illegal or ultra vires dividends
• Salary credits are made net of PAYE and NICs, and that PAYE and NICs have been accounted for correctly.

Debits to directors' loan accounts

Where a company pays a personal bill on behalf of the director (or his family) the payment is treated as if it is cash. The amount should be either:

• Debited to the director's loan account.

If not, then it should be:

• Treated as if it is a payment on account of earnings and the amount is then grossed up via the payroll, with PAYE and NICs applied.

Where a company provides a non-cash benefit for a director, the cash equivalent should be:

• Reported on form P11D

Where a loan account is overdrawn, new debits will increase the outstanding balance and there may be a taxable benefit in respect of loan interest.

Back to basics