Directors Loan Accounts - one way or another...
We always tell our clients they must never borrow from their own limited company, but for various reasons – good or bad – some of them end up doing so. So, what is the problem? In a word, tax.
If you take money out of your company, it is one of three things
- Pay, in which case it must go through a PAYE scheme
- Dividends, where you must be able to show that the company can afford to pay a dividend (i.e. that there are available reserves), or
- Loans, which are generally not a good idea.
On the technical side, there are sometimes hoops you need to go through to borrow from your own company. Does the company’s own constitution (Articles of Association) permit it? For larger loans, the shareholders need to give their formal approval. And there may be Companies Act rules to consider too.
We sometimes talk about “participators”, which means someone who has or is entitled to obtain shares in the company. For simplicity we will say directors, but that includes family too!
It isn’t just cash advances you normally think of as loans, or things like payments made on behalf of directors. We have seen “illegal dividends” creating problems here too. If the company doesn’t have available reserves, then the funds taken from the company can’t be dividends, so they are treated as loans. You may have thought there were reserves, and it turns out there weren’t. That is why you should document the decision to pay a dividend by doing a Minute and attaching your financial justification that there are available reserves. Remember too that there is no distinction between an overdrawn director’s current account and a director’s loan account.
The first tax complication is that a loan to the director can give rise to a taxable benefit. If the loan is for more than £10,000 you either must pay interest (and the official rate is 2.5% at the moment) or else the company has to return a P11D so that the individual personally gets taxes on the equivalent of the interest amount.
The second tax complication is that if the loan is not repaid within 9 months of the year end, then the company must pay a tax charge based on the outstanding amount. There isn’t a minimum amount for the loans here. It can’t just be ignored because the total is less than £10,000. So, if there is a loan of say £100 then s455 tax applies to it. And s455 tax is payable at 32.5% (25% for loans made before 6 April 2016). For the £100 loan example there is £32.50 of tax to pay on top of the normal corporation tax.
There is good news. Eventually. And that is that 9 months after the end of the year in which you repay your director's loan to the company, you can ask HMRC to repay the s455 tax. But they want a loan of s455 tax because you have a loan, and they won’t repay the s455 for a long time after you repay your loan.
Just a couple more points to make. The first is to do with “bed and breakfasting”. If you repay one loan but take another loan at roughly the same time (give or take a month) then the repayment and new loan are ignored and the initial loan is treated as still outstanding.
And secondly, if the company writes off a director’s loan, the amount written off is treated as either a distribution (if it involves a participator) or employment income (if not a participator). One way or another, they are going to get you. Directors loans? Don’t go there!
One way or another, I'm gonna find ya
I'm gonna get ya, get ya, get ya, get ya
One way or another, I'm gonna win ya
I'm gonna get ya, get ya ,get ya, get ya
Deborah Harry & Nigel Harrison