With the explosive growth of private limited companies in recent times, director’s loan account has come to occupy a special place on small company balance sheets. Whether made up of money spent by the director on behalf of his company or conversely the company paying for personal expenses of the director, DLA continues to attract the taxman’s attention as never before. This article examines the law surrounding this account in some detail.
Lending to the company (Credit balance in DLA)
Start-ups need funds, but banks and other lenders won’t gamble with their money lending to start ups. This is how generally the DLA story begins! Desperate for start-up cash, the directors use their personal funds or look up to their friends and families for help.
Money when loaned to the company goes in to the credit of a DLA and its repayment to the director obviously has no tax or National Insurance (NI) implications.
Credit balance in a DLA could also be built over a period of time as the director starts subsidising the company. To keep the company liquid, the directors will rather have their salaries and dividends credited in to the DLA, than all drawn out. A dividend credited to the DLA has no tax consequences for the company as such, and such dividends could be withdrawn whenever funds become available. As a common practice with one-man band companies, salary or bonus also gets credited to the DLA in the month of March so as to use up the director’s basic rate threshold available for the tax year. This treatment, however, has personal tax implications for the director in that PAYE and NIC are due as soon as salary and/or bonus is credited in to the DLA (s.18(1) of ITEPA 2003). Depending upon the nature of dividend, personal tax will also become due in the year paid (interim dividend) or declared (final dividend).
So far so good; but all the hell breaks loose as soon as money starts leaving the company, and in to the director’s account. Take interest on the loan, for example. Paying interest on the loan received from the director has multiple tax implications. In order for the company to claim deduction of interest as an expense, the loan should have been used wholly and exclusively for the purposes of the business of the (close) company, or of the business of any associated company of the company which is also a close company that is not a close investment-holding company (s.392(2) ITA 2007). Whilst making payment of interest, the company is obliged under s.874 of the Income Tax Act (ITA) 2007 to deduct tax (at 20%) and as a consequence file form CT61 with HMRC on a quarterly basis. The director receiving the interest is normally liable to pay tax on its receipt. However, subject to meeting certain conditions under s.392 of ITA/07 the director could claim interest relief. The primary condition is is that the company in question should be a ‘close company’ (no close investment holding companies please!). The other conditions include a ‘capital recovery’ condition (don’t take capital out so long as loan remains unpaid) under s.393(2) and either the ‘full-time working’ or the ‘material interest’ (at least 5% stake in the ordinary share capital) condition under s.393(3). It must, however, be noted that the interest relief will be unavailable if the director uses his personal ‘overdraft’ account or credit card to fund the company (s.384, ITA/07).
Lending to the director (Debit balance in DLA)
As the recession starts biting, credit balances in the DLA are giving way to ballooning debit balances. With cash all drawn out and being unable to pay off tax and other dues, companies in many such cases file for strike off, often without realising the consequences. Whilst the company law restricts lending to the director, the tax laws have complicated anti avoidance provisions in place to check tax leakage.
S.197 of the Companies Act (CA) 2006 stipulates members’ ordinary resolution for granting any loan to a director where the loan exceeds £10,000 (s.207). However, the company law restrictions can only be of academic relevance where, as in many cases, the director is also be the majority shareholder of the company!
Tax law implications are different. The taxman would be itching to treat the loan taken out by the director as a distribution at the first opportunity.
Broadly a corporation tax charge (s.455 (CTA 2010) applies where a close company makes a loan or advances money to a participator in the company or an associate of such a participator and such loan or advance remains outstanding 9 months after the accounting period has ended.
The tax charge on the company
Overdrawn DLAs attract a s.455 charge at the rate of 25% on the lower of the amount outstanding at the year end and nine months after the year end. It is repayable to the company by HMRC nine months after the end of the accounting period in which the loan was repaid.
BIK charge on the participator
Where the loan is more than £5,000 a benefit in kind will arise on the loan calculated at the HMRC official rate (currently 4% p.a), with its consequential NI and personal income tax implications. The interest could be calculated on the average outstanding at the beginning and end (s.182, ITEPA 2003) or on the daily balance outstanding (s.183 ITEPA 2003). A BIK charge will not arise where the director is paying interest on the loan at the officical HMRC rate.
What all constitutes a director’s loan?
Simply put, any money taken out of the business over and above what you’ve put in, and what is not your salary or dividend is a loan. It includes any ‘private’ payments made by the company on the director’s or his family, friends, business partner or any associated person’s behalf. Some further examples are:
- Misappropriation of a close company’s money by a participator (Stephens (Inspector of Taxes) v T Pittas Ltd [1983] STC 576, 56 TC 722).
- Shareholder unilaterally withdraws money from a company (Mirror Image Contracting Ltd v HMRC (TC02350)
Direct or an indirect loan
The participator could be an individual, or a company receiving a loan or advance in a fiduciary or representative capacity. The Finance Bill 2013 adds further teeth to this legislation in that where a close company makes a loan to a LLP or other partnership, in which there is partner who is relevant person and a participator in the close company (or an associate who is a relevant person and a participator in the close company) the company will be subject to a s.455 charge. The trustees of a settlement where one or more of the trustees or actual or potential beneficiaries is a relevant person who is a participator in the company or an associate of such a participator will also be caught by the amendment.
‘Bed and breakfasting’
This is HMRC-speak for arrangements where the loan from the close company to the participator is repaid before a s.455 charge arises, and then a new loan is given to the participator shortly afterwards. Finance Bill 2013 has introduced provisions which deny the relief if within a 30 day period repayments of more than £5,000 are made to the close company in respect of DLA and the amounts are then redrawn.
Loan write-off
Should the company write the loan off the amount written off will be treated as a deemed dividend under s.415 of ITTOIA 2005. Whilst the company need not have surplus available for such deemed distribution, where the participator is a director there is this risk that such distribution could be treated as ‘emoluments from an office or employment’ with its consequential Class 1 NIC liability. The company will not be eligible for any tax relief on the amount written off as the loan was not made in the ordinary course of business.
Loan Offset
HMRC do not normally agree that there is a right to ‘net off’ one participator’s debit balance against another participator’s credit balance, or even that a net off is possible where the same participator has a debit and credit balance with the company.
