Peter Rayney outlines the potential effect of financial reporting standard 102 on loans to company director shareholders.
The vast majority of owner-managed companies have adopted financial reporting standard (FRS) 102. FRS 102 applies to accounting periods starting after 31 December 2014, although many companies adopted it earlier.
Under FRS 102, the accounting treatment of most items remains broadly the same, but there are some notable differences. Accounting for directors’ loan accounts (DLAs), which is a regular feature for most companies, is one area that requires further consideration.
It should be noted that the rules mentioned below do not apply to ‘small’ companies that wish to account under FRS 105.
DLAs repayable on demand
Companies typically make a series of loans or advances to director shareholders on an ‘informal basis’ throughout the accounting period. The resulting DLAs will normally be cleared by a dividend or bonus within nine months of the relevant accounting period to avoid crystallising an CTA 2010, s 455 charge. In most of these cases, there is no documentary evidence indicating the terms and conditions attaching to the loan/advance. It is likely that such loans/advances will be treated as repayable on demand. However, going forward, it is recommended that this fact be clearly evidenced.
Where overdrawn DLAs are repayable on demand, they will be treated as basic financial instruments (under para 11.8 of FRS 102). A loan would be regarded as repayable on demand where the lending company has the right to demand payment at any time. The accounting treatment for these overdrawn DLAs is the same as under the old UK generally accepted accounting practice. The DLA is recorded as a current asset at its nominal face value.
Fixed term loans
Fixed term loans are also normally treated as basic financial instruments. FRS 102 requires that they be accounted for under the amortised cost basis, using the effective interest method.
Where the loan is interest-free, or if interest is charged below commercial rates, the loan account balance is recorded at its (discounted) present value. This is likely to give rise to a discount to its nominal value. In this case, the ‘discount’ element would be treated in the company’s books as a ‘distribution’ (para 11.13 of FRS 102), reflecting the benefit of the interest-free/cheap interest being provided to the shareholder.
If the loan is made at a commercial rate of interest then these issues should not arise, since no discount element would be recorded (i.e. the present value of the loan would equate to its nominal value).
Example: Interest-free fixed term loan
Patricia is a 100% shareholder of Echoes Ltd, which draws up accounts to 31 March each year. On 1 April 2017, ‘her’ company provides a £20,000 interest-free loan to her, repayable on 31 March 2020. A comparable market interest rate is 6%.
The accounting entries would be:
Director’s loan account 16,792*
Discount (= distribution) 3,207
* This is the present value of £20,000 received in three years’ time at a discount rate of 6%
Under the corporation tax ‘loan relationship’ rules, the discount would normally be regarded as a (deductible) non-trading debit. The tax treatment also applies where the debits are taken to ‘equity’ (CTA 2009, s 321). However, the tax treatment is not clear-cut in this case. The newly introduced CTA 2009, s 446A (inserted by FA 2016) states that such accounting adjustments are not recognised for corporation tax purposes. However, this legislation is only aimed at debtor relationships (i.e. loans made by a director to a company).
These special accounting rules do not affect the calculation of the taxable benefit under the beneficial loan rules. Similarly, any loan to participator tax charges (32.5% from 1 April 2016) is still based on the actual amount of the loan.
Practical Tip :
Always evidence that overdrawn DLAs are immediately repayable on demand, to avoid accounting and tax complications.
This article was first printed in Tax Insider in April 2017.