Jennifer Adams considers the tax implications of an overdrawn directors loan account.
A directors' loan account (DLA) records the transactions that occur between a company and its director, including any salary (if not directly attributed as a salary for an employee director), dividends, expenses, director's personal bills paid for by the company and reimbursements (e.g. company bills paid personally by the director and owed back by the company).
Tax implications may arise if the company is a close company (i.e. broadly a company with up to five shareholders or any number of shareholder/directors, or 'associates' (e.g. relatives: parents, adult children etc.) and the account becomes overdrawn.
Benefit-in-kind charge
If a DLA is overdrawn by more than £10,000 at any time during the tax year, the potential for a benefit-in-kind charge arises on the director and a Class 1A National Insurance contributions (NICs) charge for the company.
There are some exceptions when a taxable benefit for a beneficial loan does not arise:
- the loan is used for certain ‘qualifying’ purposes by the director e.g. buying an interest in a partnership); or
-
the company charges the director interest.
The loans are generally interest-free, and the director will be taxed on the interest that would have been payable if it had been a normal loan borrowed on the open market. Even so, it may be cheaper for the director to pay tax on the beneficial loan and the employer to pay the Class 1A NICs on the benefit, than for the director to pay interest on the loan; where the director is a higher rate taxpayer, there may be no difference.
DLA repayments
Usually, an overdrawn DLA is repaid by either crediting the loan account with salary or a bonus or a dividend from the company – dividends being preferable because no NICs are payable. However, with the potential of corporation tax rates rising over the next few years, calculations may show that in the future, taking a salary may prove to be more cost-effective overall.
A dividend payment may also not be possible if there are insufficient accumulated profits available out of which to pay the dividend. If this is the situation and a dividend is paid, such a dividend may be deemed 'illegal'.
Should the overdrawn DLA not be satisfied within nine months and one day after the company's accounting year end, a charge taxed at the higher dividend rate (currently 32.5%) is payable by the company. The tax is paid with the company’s corporation tax, the difference being that, unlike corporation tax, the ‘section 455 tax’ (CTA 2010, s 455) is refundable after the loan has been cleared. The repayment is made when the loan is repaid or cleared by funds being credited to the director’s loan account (e.g. the credit of a salary or dividend payment), or the loan is written off.
The repayment is not automatic but must be claimed using a form L2P as well as showing the claim on the corporation tax return itself. Where the loan is repaid within nine months of the end of the accounting period, relief is due immediately, i.e. the section 455 charge is not physically paid (although disclosure is still required in the company’s tax return).
When the loan is written off or waived, the amount written off is generally liable to both income tax and Class 1 NICs. However, while the Class 1 NICs is deducted through the payroll, the income tax due on the written-off loan is payable through the self-assessment system.
Practical tip
HMRC becomes aware of repayable loans by reviewing the accounts that accompany the corporation tax return on submission. An obvious flag will be if the company's reserves show a negative balance. One of the key areas of interest by HMRC under making tax digital may be overdrawn directors’ loan accounts as they will be able to see whether illegal dividends or overdrawn DLAs are present, as return submissions will be on a three-monthly basis.
