Taking money from the business for personal use when trading as a sole trade or partnership is normally easy and straightforward and unless proprietors’ drawings are a major drain on the business’ assets, there are generally no tax implications.
However, a company is a separate legal entity and, therefore, making withdrawals from a company (even if you’re a director or shareholder) requires far more consideration.
In this article, we take a closer look at the consequences of an overdrawn director’s loan account and how their impact can be reduced or avoided.
What is an overdrawn Director’s Loan Account?
If a payment is made to a director and it does not form part of their normal remuneration package (typically salary and dividends), the payment is usually set against their director’s loan account. Generally, the only other alternative would be to declare the payment is a bonus, but bonuses can be costly in tax and National Insurance.
If the director has a balance available on their director’s loan account, they can merrily draw down on their loan account with no tax implications or reporting requirements. It’s like they’ve got a bank account they can just dip into, provided the account remains in credit.
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 32.5% 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 that it is temporary – it is repaid back to the company by HM Revenue & Customs (HMRC), as the director repays the loan back to the company.
Furthermore, you only pay S455 on any advances on the loan; not the whole loan balance. So, if the loan balance went from £15,000 last year to £18,000 this year, you'd only pay S455 this year on the additional £3,000; not the entire £18,000.
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).
Beneficial Loan Benefit in Kind
The second implication of an overdrawn director’s loan account is that it can trigger a benefit in kind for the so-called ‘beneficial loan’. As mentioned above, an overdrawn director’s loan account is effectively an interest-free loan. Consequently, the director is taxed on the interest that would have been due if it had been a normal loan on the open market (the calculation of which is stipulated by HMRC).
There are a few exceptions, when a taxable benefit for a beneficial loan does not arise:
- The loan is used for certain ‘qualifying’ purposes by the director, such as buying an interest in a partnership
- The company charged the director interest (there are criteria surrounding this)
- The loan is deemed ‘small’, i.e. it is under £10,000 throughout the tax year
Watch out for Benefits in Kind
The returns for Benefits in Kind are called P11Ds. You must supply copies and the P11D(b) (which shows the company’s Class 1A National Insurance liability) to HMRC by 6th July. The P11Ds will summarize what’s happened to the overdrawn director's loan account across the tax year (not the company’s accounting year end).
This means if your company’s year end is not 31st March (i.e. the tax year), you will need to draw up your books mid-year to complete your P11Ds if you have an overdrawn director’s loan account.
If your director’s loan account is overdrawn and you think it may exceed £10,000 at any point in the tax year, it is important to complete the P11Ds and P11D(b) on time. If your P11D(b) is late, you will be charged a penalty of £100 per 50 employees for each month or part month the return is overdue. You’ll also be charged penalties and interest if you pay HMRC late.
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.
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 at the year end must be made in the company’s accounts, as well as the highest, overdrawn balance at any point in the period.
Overall, the key is to keep timely, accurate records and to keep the transactions relating to each of the directors and each of their loans separate.
How to deal 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 rule, the triggering of a benefit in kind and S455 charge can be fairly painless provided the director is intending to repay the loan quickly.
However, if the overdraft persists for some time, it may be preferable for the company to declare dividends (profits permitting). Although there will almost certainly be personal tax due on the dividends, it should be a one-off hit, whereas the impact of an overdrawn director's loan account can go on year-after-year. Dividends also do not attract National Insurance, so it is also likely to be a cheaper option too.
How we can help
If you are experiencing problems with understanding personal expenses and payments with your company, you would probably benefit from mapping out your remuneration package. This will set out how much you can draw, when and in what form, so that you don't have any surprises at the year end.
Your local TaxAssist Accountant would be happy to discuss this article and your remuneration package with you in more detail.
By Jo Nockels FCCA
Last updated July 2018
Disclaimer: The information provided is based on current guidance (at date of publication) from HMRC and may be subject to change. Any advice shared here is intended to inform rather than advise. Taxpayer's circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this information, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.