Mark McLaughlin looks at two circumstances where HMRC might challenge loan account repayments.
For more in depth discussion on this important area of business taxation, please see our recently released guide, Directors' Loan Accounts Explained.
The timing of credits (e.g., cash repayments) to an overdrawn director’s loan account (DLA) can be important. It will determine (among other things) the tax year into which the repayment falls, which can affect benefit-in-kind charges on the director; or whether a tax charge arises for the company under the ‘loan to participators’ rules for closely-controlled companies and due date for payment (or repayment) of the ‘section 455 tax’ liability.
It should be relatively straightforward to ascertain the date of a cash repayment (e.g., a bank transfer to the DLA from the company owner’s private account). However, in practice the task is seldom easy, particularly if repayments are made in non-cash form.
Transfer of assets
For example, the company owner may agree to transfer an asset (e.g., an investment property) to the company in full or part repayment of the overdrawn DLA balance (NB this has potential implications for other taxes, including capital gains tax and stamp duty land tax (or equivalent), which are not considered here).
The amount credited as a DLA repayment will be the market value of the asset. However, care is needed to ensure that the asset valuation is accurate.
Example: DLA repaid – or is it?
James is managing director and majority shareholder of Mixup Ltd. He had an overdrawn DLA of £250,000 at the end of Mixup Ltd’s accounting period ended 31 March 2020. Aside from a benefit-in-kind charge for James for 2019/20, the company faced a section 455 tax charge of £81,250 if James did not repay the overdrawn balance by 31 December 2020.
Instead of a cash repayment, James transferred a commercial property to the company on 30 December 2020. He valued the property (without a professional valuation) at £270,000. However, following an enquiry by HM Revenue and Customs (HMRC), a valuation of £218,000 was eventually agreed with the Valuation Office Agency.
Following closure of the HMRC enquiry in January 2022, the company was liable to section 455 tax of £10,400 (i.e., £250,000 - £218,000 = £32,000 x 32.5%), plus interest and a penalty.
Changing the debtor
There are other ways of dealing with an overdrawn DLA balance, such as replacing one debtor with another.
However, HMRC guidance (in its Company Taxation manual, at CTM61602) gives the following example, with a health warning:
‘…where book entries are made which mean that rather than an individual participator owing the money to the company, an associated or group company has replaced that original debtor, that does not constitute repayment. If the company which made the original loan has not received anything back then the loan/debt has not been repaid.’
‘This will also apply where repayments of loans/overdrawn DLAs are said to have been effected by moving debtor balances around a series of group/associated companies but the original lender is never actually repaid.’
HMRC may seek to challenge such arrangements by arguing that, taking a purposive approach to the ‘loans to participators’ rules, a section 455 charge should apply as there has been no repayment; or by invoking anti-avoidance rules in CTA 2010, s 464A (Charge to tax: arrangements conferring benefit on participator).
Practical tip
Ensure that any asset transfer or replacement debtor arrangements are properly documented and that the DLA debt is actually repaid.
