Insights

When you run a limited company, the finances must be carefully managed and kept quite separate from personal monies. This is a key distinction between incorporating a business as a limited company and being self-employed, or in a partnership. In the latter cases, the money belongs to you as you are taxed on all the profits, but the funds in a limited company belong to the company.

It is possible to extract or borrow company funds, but this must be documented. Records of how much you extract, or indeed lend money to the company, should always be kept. Unless you extract funds in a taxable form, any individual payments in or out of the company will be credited to or debited from a ‘director’s loan account’. This is used when you (or other close family members) take money from your company bank account that is not a salary, dividend, or expense repayment. It is also used to document any money that you loan to the company.

Tax rules for overdrawn director’s loan accounts

It is possible to borrow up to £10,000 from your limited company without any personal tax implications. For any loans above this amount, interest must be paid at an amount equal to HMRC’s published rate (2.6% currently), or a benefit in kind charge paid on the unpaid interest.

However any amounts of directors’ loans not repaid within 9 months of the company’s accounting year-end attract ‘section 455 tax’ on the outstanding value of the loan. This tax is payable by the company and is 32.5% of the amount of the loan outstanding at that date.

No ‘bed and breakfasting’ allowed

It is not possible to repay and then re-borrow money straight away to avoid section 455 tax.  Under HMRC anti-avoidance provisions, directors cannot repay loans just before the tax trigger date and then re-borrow for the new period - unless the amounts involved are very small. They must leave a 30-day gap for any repayments of £5,000 or more which are then re-borrowed. Failure to do this will trigger section 455 tax.

One way to avoid the 30-day rule and avoid issues with bed and breakfasting is to elect to receive a taxable payment, like a dividend or bonus, using that income to repay the borrowings. It is also advisable to keep any loan repayments and re-borrowings below £5,000 to avoid further scrutiny.

Precautions when using a director’s loan account

When using the director’s loan account as a source of funds, it is always advisable to seek professional advice first. This ensures you will be acting appropriately, not exposing yourself to the risk of an HMRC enquiry and also, very importantly not paying more for finance than you need to due to the section 455 tax legislation.

HMRC will periodically check the tax position of family and owner-managed companies and this will often involve a review of the relevant directors’ loan accounts. Given the disruption so many businesses have faced recently due to COVID-19, with directors possibly needing to access company finances as a last resort, it is especially important to understand the status of your director’s loan account. As this article explains, if you have withdrawn monies, these should be repaid in full within the relevant period to avoid additional tax liabilities.

What does HMRC look for when checking your director’s loan account?

Director’s loans are classed as  ‘loans to participators’ and possibly also a benefit-in-kind by HMRC and are taxed accordingly. If HMRC looks into your director’s loan account, they may request a detailed analysis with records of all debits and credits. They may also want to know if any bonuses paid through the director’s loan account were taxed and if there was any ‘bed and breakfasting’ of loan funds.

Poorly managed director’s loan accounts trigger enquiries

In some cases, company directors have faced issues because they have not maintained detailed records of their director’s loan account transactions. By way of an example to highlight what can happen, Matharu Delivery Service Ltd faced an enquiry into their corporation tax self-assessment return and were required to provide a copy of their director’s loan account transactions for each director. HMRC wanted to see the dates, amounts and descriptions of each transaction. When the information was submitted, HMRC objected that it was not fully itemised or listed in chronological order. In spite of being advised that this was an accurate record and the only one available, Matharu incurred non-compliance penalties for failing to maintain adequate record keeping. HMRC’s argument was that the information was presented poorly, making it difficult to reconcile against bank statements and other paperwork. The company appealed against the penalty but after lengthy discussions, this was dismissed by HMRC.

Liquidating your company and director’s loan accounts

A final very good reason for ensuring your director’s loan account is not overdrawn is if you are considering winding up your company in the future. The liquidation rules require all debts – including those owed to your company – be repaid in full before any remaining funds can be released from the company.

If you wish to discuss your director’s loan account to understand whether you might have additional tax liabilities, please contact us at partners@rjp.co.uk.