Dealing with an overdrawn Directors Loan Account
Newsletter issue - April 2021
Many companies use 31 March as the accounting reference date. As such, now is a good time to review the position of directors' current accounts for close companies.
It is a common misunderstanding that if the company charges a commercial rate of interest on any loan made to the participators or employees there are no tax consequences. In fact, whilst doing this does protect against a benefit in kind arising, there is a further consideration for the company.
A charge arises under CTA 2010, s. 455 where amounts are owing at the accounting year end and these are not repaid within nine months. The charge is made at 32.5% of the amount outstanding, but it is temporary and is repaid once the owed monies are repaid to the company.
S.455 doesn’t apply to:
- loans made in the ordinary course of the company's business. This includes not only loans made by banking businesses but also credit terms on the sale of goods to a participator which are the same as the credit facilities offered to members of the general public, providing the credit period does not exceed six months
- loans not exceeding £15,000 in total, made to directors or employees working full time for the company (or an associated company) who do not have a material interest (broadly this means controlling more than 5% of the share capital, or rights to assets) in the company; and
- since 25 November 2015, loans to charitable trustees for charitable purposes.
However, the charge does apply to overdrawn directors' current accounts. The £15,000 exception doesn't apply if the director is also a shareholder with a material interest - there is no de minimis on the size of the loan that will trigger a charge.
The nine-month grace period does give the director an opportunity to pay the loan back. However, many may struggle to do that from private funds this year due to the Covid-19 crisis.
Fortunately, as participators in close companies tend to have a high degree of control over their remuneration, there are some other options to help.
Vote a bonus
Voting an additional payment of salary and crediting this to the overdrawn account is one method. The advantage of doing this is that it attracts a deduction from the company's taxable profits. The drawback is that it must be processed via the payroll, and have tax and NI deducted.
Vote a dividend
This is similar method but involves crediting a dividend instead of a salary. There is no deduction for corporation tax, but there is no NI to pay either. The dividend will be taxable in the hands of the participator, but at lower rates than apply to bonuses. It will also be payable via self-assessment rather than PAYE so there is a timing advantage.
This will only be an option if there are distributable profits to pay dividends from. This may be affected by Covid-19, so a company must exercise additional caution to ensure a clear picture is obtained before voting the dividend.
Write off the loan
If the loan is formally written off, the participator is treated as receiving a distribution equal to the amount released. There is a risk that HMRC will try to treat this as "earnings" for NI purposes, so if available the dividend option is usually better. The write-off should be made formally in writing, or there is a further risk that the debt would be pursued in the event of a liquidation.