It is also an area that most clients do not clearly understand. I hope the this blog post will help in ensuring that directors keep taxman at bay and the company pays the minimum amount of tax within the law.
How does the Director’s Loan Account work?
If a director pays money into the company, it is accounted for in the Director’s Loan Account which is then deemed to be in credit. Withdrawals can also be made, and if the account remains in credit, there are no tax implications.
It is when the account goes overdrawn that potential tax issues arise as the overdraft is seen as an interest-free loan.
Section 455 Corporation Tax charge
HMRC calculates S455 to be 25% of the outstanding loan amount, but there are three possible outcomes about this charge:
1 The loan is repaid before the last day of the company’s year-end
If the loan is repaid before this time, no charge is made, and the loan does not need to be disclosed on the supplementary pages of the Company Tax Return (CT600)
2 The loan is repaid within nine months and one day of the year-end
The loan should be disclosed on the tax return, as well as the calculation of tax at 25%. The S455 charge at 25% of the remaining loan amount will not physically be paid, however if the loan is repaid in this timescale.
3 The loan is not repaid within nine months and one day of the company year-end
You will have disclosed the existence of the loan on your Company Tax Return, and 25% of the outstanding amount should be added to your Corporation Tax liability. HMRC will also charge interest on the unpaid amount.
Benefit in Kind
A benefit in kind sometimes arises when a Director’s Loan Account goes overdrawn. The benefit is the amount of interest that would normally have been charged on the loan.
There are always exceptions to the rule, however, and if specific ‘qualifying’ purposes apply to the loan, a benefit in kind may not arise:
- if the money is used to purchase an interest in a partnership
- the company has charged the director interest on the loan
- the loan amount is below £10,000 for the entire year (this limit was £5,000 for the financial year 2013/14)
Complications and variations
An overdrawn Director’s Loan Account could result in a benefit in kind, a Section 455 Corporation Tax charge, or indeed both. The outcome depends on the amount of the loan, as if it rose above £10,000 at any time during the company’s financial year, it would result in a benefit in kind.
A loan of less than £10,000 means that a benefit in kind does not arise, but if the loan is not repaid within nine months following the end of the company’s financial year, a Section 455 tax charge would be payable.
Stringent record keeping is vital to avoid errors, and remain compliant with HMRC. Entries need to be made as they occur rather than left until a later date so that figures can be fully relied upon.
The consequences of poor record keeping include paying the wrong amount of tax and incorrect disclosure to HMRC. Each overdrawn loan amount must be included in the company accounts, along with a note of the largest balance during the financial year.
Good record keeping provides transparency and demonstrates responsibility or otherwise on the part of directors, who should each have their loan account.
How to deal with an overdrawn Director’s Loan Account
The main focus should be on when the loan will be paid off. If it is repaid quickly, it may just be a case of disclosing the loan on the Company Tax Return, with no actual payment becoming due.
On the other hand, if the loan will not be repaid quickly, it might be worthwhile declaring a dividend in order to repay the loan. A downside of this as far as an individual director is concerned, is a potential personal tax implication as a result of the benefit in kind, but advantages are also apparent:
- dividends do not attract National Insurance
- paying off the loan using a dividend is probably going to be the quickest way to deal with the situation