Taking money from the business for personal use when trading as a sole trade or partnership is fairly painless and unless proprietors’ drawings are a major drain on the business’ assets, there are generally no tax implications.
A company on the other hand is a separate legal entity and, therefore, making withdrawals from a personal company requires far more consideration. In this article, we take a closer look at the consequences of overdrawn director’s loan accounts and how their impact can be reduced or avoided.
An overdrawn Director’s Loan Account
If a payment is made to a director and it does not form part of the director’s remuneration package or is not an allowable expense for the company, the payment must be set against their director’s loan account.
If the director has a balance available on their director’s loan account, then the director can merrily set such a payment against their loan account with no tax implications.
However, once the available funds are exhausted, the director is in default and, therefore, a debtor of the company. This can have two implications:
Corporation tax charge - S455
Firstly, if a balance remains outstanding on their loan account at the company’s year end, this can lead to a tax charge on the company called S455. This only applies to ‘close companies’ though- generally speaking a company with less than five shareholders/ directors.
The loan account balance must be shown on supplementary pages of the company’s corporation tax return (CT600) and the S455 charge is calculated as 25% of whatever balance was outstanding on the director’s loan account at the period end. The S455 tax is payable nine months and one day from the end of the relevant accounting period.
An overdrawn director’s loan account is effectively an interest-free loan, so S455 is supposed to deter the company from providing such generous perks to its directors. However, S455 is rather unusual in so much as it is temporary- it is repaid back to the company by HM Revenue & Customs (HMRC), as the loan is repaid by the director to the company.
Where the loan is repaid within nine months of the end of the accounting period though, relief is due immediately, i.e. the S455 is never physically paid (although disclosure is still required in the company’s tax return).
Benefit in Kind
The second implication of an overdrawn director’s loan account is that it can trigger a benefit in kind. As mentioned above, an overdrawn director’s loan account is effectively an interest-free loan, so the benefit equates to the interest that would have been due (the calculation of which is stipulated by HMRC). There are a few exceptions, which can mean no benefit arises:
- The loan is used for certain ‘qualifying’ purposes by the director, such as buying an interest in a partnership
- The company chose to charge the director interest (the tests for this are fairly stringent)
- The loan is deemed ‘small’, i.e. it is under £10,000 throughout the year*
*£5,000 during 2013/14; £10,000 from 2014/15 onwards
The interaction between S455 and the benefits code
The interaction between S455 and the benefits code can lead to some unexpected consequences:
- A S455 charge may be mitigated by an election of a dividend after the year end. However, if the balance on the loan was over £10,000 at some point, then a benefit in kind would arise.
- A loan remains under £10,000 throughout the year but does not get repaid by the year end or within the nine months following. This would result in a S455 charge payable but no benefit in kind arising.
So as you can see, an overdrawn director’s loan account could result in a S455 charge or a benefit- or both.
Record Keeping and Disclosure
Good record keeping with regards to a director’s loan account is essential. Poor records could result in the misallocation of expenses/ payments and ultimately, the right taxes not being paid.
Record keeping is also important because disclosure of the balance on each overdrawn director’s loan account must be made in the company’s accounts, and the largest balance during the year must also be stated.
This would ensure that a loan account that starts and ends below £10,000 is highlighted and also shows lenders and other interested parties how responsible directors are being.
Overall, the key is to keep timely, accurate records and to keep the transactions relating to each of the directors separate.
So what’s the best solution for dealing with an overdrawn director’s loan account?
As with a lot of scenarios, it’s hard to give one solution that will suit everyone’s circumstances. But as a general rule, the triggering of a benefit in kind and S455 charge can be fairly painless provided the director is intending to repay the loan fairly quickly.
However, if the overdraft may exist for some time, it may be preferable for the company to declare dividends (profits permitting). Although there may be personal tax implications for the directors because of the benefit in kind arising, it is likely to be the quickest way for the overdraft to be cleared.
Furthermore, dividends do not attract National Insurance, so it is also likely to be the cheaper option too.
If you are experiencing problems with understanding personal expenses and payments with your company, your local TaxAssist Accountant would be happy to discuss this article and your circumstances in more detail.
By Jo Nockels