Mark McLaughlin looks at ‘close’ company overdrawn directors’ loan accounts and tax liabilities under the ‘loans to participators’ rules, following HMRC enquiries.
Enquiries by HM Revenue and Customs (HMRC) involving businesses often extend to the business owners themselves. Tax return adjustments can occur, even for honest business owners.
HMRC categorises business profit irregularities as ‘non-extractive’ or ‘extractive’.
Non-extractive adjustments
Non-extractive irregularities are broadly understatements of profits or excess tax relief claims not involving funds being taken out or diverted from the company.
For example, non-extractive amendments to profits might arise through private use adjustments (for sole traders or partners), or disallowances due to innocent misunderstandings about complex tax law.
‘Hand in the till’?
Extractive irregularities occur broadly where (say) money or value is withdrawn by a company’s owners. HMRC might seek a settlement of the evaded tax by charging corporation tax on additional profits. Furthermore, if a director shareholder has benefited from receiving omitted company turnover, or from having funds diverted to them, HMRC could propose that the omissions are debited to the individual’s director’s loan account (DLA). This could cause a DLA in credit to become overdrawn. If so, a close company will be faced with a potential liability under the ‘loans to participators’ provisions (CTA 2010, s 455). Furthermore, an income tax liability may arise for the director under the ‘beneficial loan’ rules.
If the DLA balance is being released or written off, the company may be able to claim relief from the section 455 charge under a contract settlement, leaving only interest and penalties. However, the director shareholder will normally be liable to income tax on the release or write-off (i.e., like a dividend).
Mixed fortunes
In Gopaul v Revenue and Customs [2023] UKFTT 728 (TC), the company operated a take-away pizza business. The appellant was the only shareholder and director. Following enquiries, HMRC considered that the company’s turnover had been systematically suppressed, and the appellant’s behaviour was deliberate. HMRC subsequently assessed corporation tax on undisclosed profits, and section 455 charges. HMRC treated omitted company sales as funds misappropriated by the appellant and treated them as loans or advances to participators for section 455 purposes.
On appeal, the First-tier Tribunal (FTT) found HMRC had failed to discharge its burden of proving the taxpayer knew that the company had a section 455 liability and had deliberately omitted it from the company’s tax return. The appellant’s appeal was partly allowed.
By contrast, in New Claire Wine Ltd v Revenue and Customs [2024] UKFTT 00014 (TC), the company was a wholesaler. HMRC identified significant stock and other discrepancies, including products sold where no purchase invoices could be found. HMRC subsequently charged VAT, corporation tax and section 455 liabilities (on an increased overdrawn DLA balance), plus a penalty for deliberate tax return errors. On appeal, the FTT found that the company advanced the monies to the directors, and that the company’s behaviour was deliberate.
Practical tip
In Gopaul, the success of the taxpayer’s appeal on section 455 penalties turned on his knowledge (or lack thereof) about how section 455 liabilities arise. The tribunal commented: “…there is no evidence that Mr Gopaul even knew at the time the returns were made, that the extraction of money from his own company could trigger a corporation tax charge…HMRC have failed to meet their burden of showing that the Company acted deliberately in omitting the section 455 liabilities from its corporation tax returns.”
