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Brief overview

It’s not so unusual for a director to withdraw funds from his/her company over and above any salary or dividend entitlement. If the director has already put money into the company (i.e. lent to the company) then repaying those funds from the directors loan account is tax free. This is because loans (including their repayment) are not “income” for tax purposes – it’s merely the repayment of the directors own money – repayment of a loan.

Occasionally, directors will take payments in excess of the funds introduced into the company and therefore the director becomes a debtor, commonly known as an overdrawn director’s loan account.

To stop directors from taking tax free cash from their company by way of “loans” there are anti-avoidance rules covering loans made by a close company to  it’s directors ( a close company is one that’s controlled by no more than five shareholders).

The main rules

The company must pay Corporation tax on any loans to directors which have not been repaid within nine months after the end of the accounting period in which the loan(s) was made.

For many years the tax rate has been 25%. However since the introduction of the new “dividend” “tax” of 7.5% in the Finance Bill 2016, it has been increased to 32.5%.

For example a loan for £100,000 was made before 4th April 2016 attracted a Corporation Tax charge of £25,000, but if this was made on 6th April 2016 or after then the Corporation Tax charge would be £32,500.

As above, if the loan is repaid within the nine month period then no tax is due.

Restriction

If, when the loan is repaid, another new loan is taken, then no relief will be available.

Partnership loans

Loans to Partnerships or Limited Liability Partnerships are also caught by these rules.

Example: Tom is a director in a close company, James Ltd. This company makes a loan of £20,000 to Simon LLP, of which Tom is also a member. James Ltd would have to pay tax of £6,500 (32.5% of £20,000) if the loan was not repaid within the nine month period.

Indirect loans

The rules also apply to loans made indirectly. Example; James Ltd, lent B Ltd £15,000 and B Ltd then loaned £15,000 to Tom. The loan could be caught and £4875 tax would be payable by James Ltd.

Dividends

An overdrawn loan account can be repaid by dividends, provided dividends are credited to the loan account. If dividends are taken in cash and later paid into the company, this will be regarded as falling within the repayments provisions and could, potentially, fall back within anti – avoidance legislation.

Tax on the director

If interest on a loan (at a commercial rate) is not paid to the company by the director, the director is deemed to have received a “Benefit In Kind (BIK) and the value of that benefit is taxed on the director at the tax rate payable by that director. Currently the interest benefit is calculated at the rate of 3% per annum (HMRC “official rate”) for the period of the loan – whether it’s repaid within the nine months period or not.

To avoid a BIK charge the director can make an interest payment to the company or the interest amount can be debited to the DLA in the company accounts.

Notification to HMRC

The company is required to notify HMRC of all the BIK’s received by it’s directors and employees (with minor exceptions) on a form P11d by 6th July each year. Incorrect and late returns could trigger a penalty of £3,000 each.

All BIK’s are based on the tax year and not the company’s trading year and therefore it’s not always easy to calculate the actual beneficial interest by the P11d deadline date.

Consideration should therefore be given to charging interest on directors overdrawn loans within the company’s accounting year to avoid a potential costly omission or error on the P11d. Interest can either be physically paid or debited to the DLA.

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