Director’s loan accounts under the microscope

It looks as if HMRC is clamping down on directors’ loan accounts as it works to close the £14.7billion small business tax gap.

Its desire to clampdown on transactions between ‘close’ companies and its participators, including directors’ loan accounts, was highlighted in a recent consultation exercise.

A director’s loan account records transactions between a director and their company that are not salary, dividends or reimbursed business expenses.

A close company is controlled by its directors or by five or fewer participators. A participator is someone who has an interest in the capital or income of the company, such as a shareholder.

An overdrawn director loan account can already trigger scrutiny, with the potential of penalties in the pipeline. There may well be additional tax charges, particularly where balances remain outstanding beyond statutory deadlines.

The overdrawn position is more common than people think. It can happen gradually over time, going unnoticed until the time comes to prepare year end accounts, as drawings are taken outside any salary or dividends paid.

It is a common situation in owner-managed business and, in simple terms, it means the director owes the company cash – even though going overdrawn may not have happened intentionally.

The key to compliance and avoiding a bill from the taxman for more charges is understanding when it will become an issue – and to act accordingly.

The key date is nine months and one day after the end of the business’ accounting period. If the loan balance remains outstanding at that point, the company may become liable to pay what is known as Section 455 tax.

This is a temporary corporation tax charge that applies to loans made by close companies to directors or shareholders.

For loans made on or after 6 April 2022, the Section 455 rate is 33.75 per cent and for those made before that date the rate is 32.5 per cent.

However, it is important to note that this charge is not permanent. Where the loan is later repaid, the company can reclaim this Section 455 tax from HMRC.

In most cases, the claiming back of the tax paid can only be made nine months and one day after the end of the accounting period in which the repayment occurs.

Claims are made through the corporation tax return, and as such accurate records of repayments are essential.

An overdrawn director’s loan account can also lead in some circumstances to a benefit in kind charge that sits separate to any Section 455 liability.

If the loan balance is more than £10,000 at any point during the tax year, and interest is not charged at HMRC’s official rate, then the loan is treated as a taxable benefit.

The consequences of that can be an income tax bill or Class1A National Insurance contributions payable by the company.

And there are also anti-avoidance rules to be aware off. Where a loan is repaid and £5,000 or more is borrowed again within 30 days, the repayment may be ignored for Section 455 purposes.

And where there is an intention or arrangement to repay a loan and then draw it again, HMRC may treat the loan as never having been repaid.

Depending on the circumstances an overdrawn account can be dealt with legitimately with repayment options available.

This may be a cash repayment by the director or through dividends, if the business has sufficient distributable reserves and correct procedures are followed

Repayment can be made in the form of salary or bonus, which brings PAYE and National Insurance considerations into play.

Or the matter can be dealt with by charging interest on the loan at or above HMRC’s official rate.

It is vital that directors regularly review their director loan account and check if it is overdrawn and the size and duration of any outstanding balance. Knowledge gives clarity.

And it also offers the flexibility to deal with any issue arising, reducing the risk of having to pay an unexpected bill from HMRC.

• To discuss your situation or any issues raised by this article please contact me on 01772 430000