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HM Revenue & Customs (HMRC) do a toolkit for advisers. This is our own version with planning points.

At a glance

HMRC instructs its staff to examine directors' private expenditure during the course of an enquiry into a close company's books and records. In most cases the company will be expected to produce a transaction history of any director's loan or current account.

Overview

What's new

An overdrawn director’s current account is the same as a loan account

An overdrawn director’s current account that is not repaid is treated as an outstanding loan and this may create tax complications for both the company and its director:

Company tax charge on outstanding loans to participators: s455 CTA 2010

Top tip: the company and relevant director should agree the treatment of aggregating or offsetting loan accounts at the time that the loans are made or when two are to be offset and record this in a board minute at the time. Better still for the board to pass a resolution to agree treatment. Back-dating of any of this documentation is bad practice unless there is a genuine reason why it was not possible to record the details of a meeting at the time.

Planning tip: Pension lump sums can be taken tax free up to 25% of the value of the fund without any further pension having to be taken yet. Consider taking a tax free lump sum to repay an overdrawn directors loan account. 

Taxable benefit: if the loan is interest-free and exceeds £10,000 (limit £5,000 up to 5 April 2014)

Top tip: if a director is charged and pays interest at HMRC's official rate on loans with a balance in excess of £10,000 this reduces the reporting requirements. It is sensible to work out whether it is cheaper for the director to pay tax on the beneficial loan and the employer to pay the Class 1A NICs on the benefit or for the director to pay interest on the loan. Where the director is a higher rate taxpayer there may not be a difference. In term of reporting, if interest is charged, it is still necessary to report the loan on form P11D however there is no Class 1A for the employer. If the director does not pay the interest you must prepare a P11D and he will need to report the benefit under Self Assessment and this will probably be adjusted for via a PAYE coding which will need checking.

Write off or release of an overdrawn director’s loan

When a Close company writes off or releases a loan made to a director:

a) who is a participator, the amount released is treated as a distribution, or

b) who is not a participator, the amount is taxable as employment income.

In most small companies the director will be a shareholder and will be entitled to vote at board level and so will be a participator. The distribution treatment will apply to any loans made and written off to the director or his family.

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.

Conversely, the company can also vote a bonus and treat the write off as earnings. If it does this it will need to ensure that it is mindful of reporting requirements under Real Time Information (RTI) reporting for PAYE.

Write off of a loan from a Director

Where a Director makes a loan to a company which is written off a number of different tax consequences may well apply: see Close Company Loans Toolkit.

Changes effective from 20 March 2013

From March 2013 three new measures were introduced to extend the s455 tax charge to deter tax avoidance using close company loans.

These measures counter the following arrangements where a close company:

These affect new loans and repayments made on or after 20 March 2013 and are covered in detail in our Close Company Loan Toolkit

Overview and FAQs

Income Tax

National Insurance Contributions (NICs)

Loan write off: on termination of employment or office

Corporation Tax

Reclaiming Corporation Tax after repayment or write off

Planning point:

Where a company is being liquidated and there is s455 tax to recover there may be complications. The directors loan account will need to be repaid, (not waived), to avoid income tax treatment and possible NIC charges. Care is required in accounting for the loan account and if possible it should be repaid in cash; if this is not possible it will be for the liquidator to decide whether they will accept a contra against the distributions due to the shareholder director as part of the liquidation. If they will accept this it will need to be properly documented. The normal timescales for reclaiming the s455 tax will apply despite the liquidation process. The company will need to still exist at the tax repayment date and this may delay the completion of the liquidation process.

Credits to a director's loan account

Bookkeeping can be a major headache for many running a small business and a director's loan account will often be left for an accountant to review at a period-end. Unfortunately under Real Time Information Reporting (RTI) this may be a dangerous practice.

Planning points: rather than review a loan account at the year end and then vote salary or dividends to repay it, it may be sensible to vote both at the start of the year. This way a director has funds available to draw on without the added complication of having to review for RTI reporting.
The company may also register to run an Annual Scheme for RTI which will also reduce reporting requirements.

Also check that:


Debits to directors' loan accounts

The company should review expense headings to make sure that all payments made to or on behalf of a director or his family are identified.

These payments should be either:

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.

If care is not taken as to the timing of debits and credits to the loan account, unexpected tax on pecuniary liabilities can arise.

Back to basics: How does a director get to create a loan?

Typically a director will have what is known as a "current account" with the company. This should be in credit and it will have been created by bookkeeping when the company owes the director for something such as expenses that the director has incurred on the company's business, and has not been reimbursed.

For example: a director purchases a desk on behalf of the company for £1,000. Bookkeeping entries are:

DR Fixed Assets - £1,000
Cr Directors Loan - £1,000

A director may borrow funds from the company by an agreed loan, as approved by shareholders, or a director may borrow funds on account ahead of an anticipated dividend or as a salary. Sometimes by error or design illegal borrowing (illegal because it is not shareholder approved) takes place. In any event borrowing creates a loan, and if the loan is not repaid there will be tax consequences. If the loan is made as an advance of salary, there are also implications for reporting under RTI.

Small print and Links

Links:

Updates

16/11/17 Updated writing off a loan from a director.

 

Every effort is made to ensure that our notes are up-to-date however please note our terms and conditions. 

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