A director’s loan account (DLA) is broadly an account in the company’s financial records that records all transactions between a director and the company. Such transactions will include payments on account of final salary, and any dividends if declared.
In reaching the end of an owner-managed company’s accounting period, it is not unusual to find that insufficient profits have been generated to cover the amount that has been withdrawn, even after taking salary and the director shareholder’s dividends into account. Thus a debit balance is owed back to the company. The director is required to repay this amount before the company’s corporation tax is due nine months after the year end; if unpaid, the company is liable to an additional tax charge and in specific circumstances the director may also be required to pay additional tax and NIC under the ‘benefit-in-kind’ rules.
Tax on the company
If a loan is made to a full-time working director whose interest is more than 5% in the company’s share capital and the loan is not repaid by the due date, legislation charging tax on a ‘loan to a participator’ (CTA 2010, s 455) comes into play. This section broadly applies to unpaid loans in excess of £15,000 and charges the company to an additional tax charge equal to 25% of the loan outstanding.
When the loan is subsequently repaid, repayment of the tax can be claimed, but it will not be paid until nine months after the end of the CTAP in which the loan is repaid or reduced (s 458).
It is not only director shareholders who are subject to the rules – section 455 also applies to unpaid loans made by a close company to other ‘participators’ as well (e.g. loan creditor) or their ‘associate’ (e.g. spouse, parent, grandparent, child, grandchild, brother or sister).
The reason for the charge is that HMRC broadly considers the withdrawals to be a possible technique either to avoid the PAYE/NIC charge which would be payable if the ‘loan’ had instead been paid to the director as salary, or to avoid the payment of higher rate tax on dividends.
Details of the loan are required to be declared on the company’s tax return, with the usual interest being charged on payments made late to HMRC.
Tightening of the rules
Prior to anti-avoidance rules introduced in the Finance Act 2013, it was not unheard of for repayment to be made just before the due date to avoid the s 455 charge, and for the funds to be re-borrowed shortly after. The Finance Act 2013 introduced measures intended to strengthen the regime, notably where loan repayments totalling at least £5,000 are repaid but then further loans of at least £5,000 are made within 30 days. In this situation, the repayments are matched to the later advance, in effect saying that no repayment has been made. These restrictions do not apply if arrangements are in place to repay via a dividend or bonus, as this will give rise to an income tax charge.
The measures go further. If there are outstanding loans of at least £15,000, then the repayment will be ‘matched’ should arrangements be in place to redraw an amount of at least £5,000 at any time. Thus the company’s tax charge will only be cancelled to the extent that the repayments exceed the amount of the new loan. Similar provisions apply as with the ‘30 day rule’ in that no charge is levied should the repayment be via a dividend or bonus resulting in an income tax charge.
Tax on the director
Should the balance owing on the ‘loan’ exceed £10,000 at any time during a tax year, the director/shareholder is considered to have received a ‘benefit-in-kind’ from his employment, the charge being at his highest rate of tax and declarable on HMRC’s benefits and expenses form P11D. However, no charge will be levied if the director pays interest on the loan of at least the ‘official rate’ (currently 3.25%). The reason for this rule is that had the director not borrowed from the company, he would have borrowed from a commercial lender – hence the ‘benefit’ of borrowing from the company at a lower or nil rate.
National Insurance contributions charge
Paying interest at the ‘official rate’ or higher also means no NIC charge, which will otherwise be levied on any salary drawn.
The Companies Act 2006 (at s 413(3)) requires disclosure in the notes to the annual accounts of any advance or credit granted by the company to directors, specifically:
(a) the amount of loan;
(b) the interest rate used;
(c) the main conditions of the granting of the loan; and
(d) details of any amounts repaid or written off.
Disclosure is also required under FRS 8 ‘Related party disclosure’.
Repayment of the loan
Repayment of such loans can be by direct personal repayment, declaration of dividend (if the director is also a shareholder and if the company has distributable reserves), the voting of a bonus or by the company formally writing off the loan. The benefit of using either the dividend or bonus method will depend upon whether the director is a higher rate taxpayer; if he is, it might be more tax efficient for the company to pay the tax instead.
Write-off or release of the loan
A loan written off is treated as a distribution grossed up at the dividend tax rate (ITTOIA 2005, s 415). The director shareholder will be liable to higher rate tax if appropriate, the declaration being on the personal tax return.
However, should the loan have been made to a director, HMRC may consider that the write-off is really earnings, and NIC needs to be accounted for (CWG2 (2010); see HMRC’s National Insurance manual at NIM12020, Company Taxation manual at CTM61630, and HMRC’s Directors Loan Account Toolkit). This attempt could possibly be countered by arguing that the write off has been made in the directors’ capacity as a shareholder, rather than as an employee.
If a loan write-off occurs on the death of the director, there is no tax or NIC charge (ITEPA 2003, s 190). The company is denied corporation tax relief when the loan is written off on loans made to participators, who may also be directors (CTA 2009, s 321A).
Unpaid overdrawn DLA on liquidation
The liquidator can demand that a director repays the loan. The payment will then be used to pay any company’s creditors. The liquidator is permitted to take legal action against the director or even make him bankrupt to recover the loan.
HMRC will want to know that the overdrawn loan account has been paid. In many cases, they will be aware of the situation because this information should have already been reported on previous accounts or tax returns. If the liquidator does not have the funds to make payment, then HMRC may pursue the director personally.
HMRC may try to argue that amounts withdrawn are really payments on account of employment income, and seek to apply PAYE. In addition, on write-off, they may seek to recover National Insurance contributions, despite the write-off being treated as a dividend. To counter this argument, the dividend should be properly voted, documented by minutes, and dividend vouchers issued as required by the Companies Act 2006.