Chris Thorpe looks at the potential issues in using a directors’ loan account.
One of the features of being a shareholder in a limited company, as opposed to being a sole trader or partner, is that you cannot just help yourself to company funds whenever you like. It’s no longer your money; it belongs to the company.
Those funds need to be declared as dividends or salary, but another way to extract funds from the company is simply to borrow money via a directors’ loan account (DLA).
The borrower
If the borrower is also an employee or director and they pay a market rate of interest for their loan, there are no income tax implications. If the rate is below this, and the amount borrowed is more than £10,000, a benefit-in-kind income tax charge will arise (and a Class 1A National Insurance contributions (NICs) charge on the company). Someone who is purely a shareholder will not face this charge; however, if the loan is subsequently written off that sum is taxed as a dividend. An employee or director will likewise be taxed on that write-off as a bonus, with the corresponding NICs consequences.
Whilst someone who is a director and shareholder should only be liable to income tax on the write-off as a dividend, HMRC could argue that the write-off was in respect of their role as a director rather than a shareholder.
The company
In addition to the potential income tax liabilities on the borrower for the loan, the company also faces tax consequences. The company must pay a ‘deposit’ of 32.5% of the outstanding sum existing nine months following the accounting period; this deposit is known as a ‘section 455 charge’ (from CTA 2010, s 455) and is repaid to the company when the loan is repaid or written off.
This section 455 charge does not apply when any full-time director or employee who owns less than 5% of the company’s ordinary shares takes out a loan. It only applies when a participator takes out the loan from a close company, i.e., shareholders, five or fewer of whom control the company (or any number if all participators are directors).
If the loan is repaid within the nine months following the accounting period, the section 455 is never paid at all, but loans are often left open beyond the nine-month threshold. What will often happen is that a loan is repaid by the participator, the section 455 tax is repaid to the company, and then another loan is taken out immediately thereafter, and so on. Clearly, a cash flow problem is being resolved; a shareholder need not worry about distributable reserves, income tax on dividends and salaries; they can just live off borrowed monies ad infinitum.
Unfortunately, HMRC has addressed this trick, known as ‘bed and breakfasting’.
Anti-avoidance traps
If someone repays a loan of £5,000 or more to the company and within 30 days takes out another loan, the section 455 tax which would ordinarily be repaid is matched against this new loan and withheld.
Even outside that 30-day boundary, if the outstanding loan is £15,000 or more and subsequently repaid and a further loan of £5,000 or more is borrowed as a new loan, the section 455 tax can still be matched against that new loan. This is known as the ‘intentions and arrangements’ rule to catch those simply waiting for the 30 days to expire.
One way to avoid these rules (besides staying below these thresholds) is to make the repayments through monies subject to income tax (i.e., dividends or salaries). By having the dividend or salary credited directly to the DLA to clear the loan, it will mean the section 455 tax will be repaid, even if another loan is subsequently taken out. HMRC is getting their ‘pound of flesh’ through the income tax on the salary or dividend, so no mischief is being done.
Practical tip
Any loans taken from a company should be repaid as soon as possible, at least within the nine months following the accounting period, to avoid a CTA 2010, s 455 charge arising in the first place. Beyond that, repay those loans with dividends or salary directly from the company so that, if subsequent loans need to be taken out (even beyond the next 30 days), the bed and breakfasting rules will allow the company to reclaim the section 455 tax.
