An ‘Overdrawn Directors Loan Account’ is a common term used to describe money owed to a close company (a company controlled by 5 or fewer shareholders) by a director-shareholder.
The most common situations for an overdrawn directors loan account to arise is where a director-shareholder draws money from the company but does not have existing funds in the company to draw from.
For corporation tax purposes, such debts are known as ‘Loans to participators’.
This term has been extended to also include loans by the company to both a partnership in which one of the participators (or associate of a participator) is a partner and a trust of which a participator or associate is an actual or potential beneficiary.
The tax treatment of a loan to a director
Where a loan is made to a director, including cases where the director is not a shareholder, and the loan exceeds £10,000 it is treated as an employment related loan. A taxable benefit will arise on this loan if the director does not pay interest to the company at the official rate of interest determined by HMRC.
The taxable benefit of the interest free loan is required to be reported on form P11d and cannot be covered by a dispensation.
Class 1A NICs will be payable by the company on the beneficial loan interest and the director will also be subject to income tax on the benefit received.
Tax implications for the company
When a close company makes a loan to a participator, usually a director or shareholder, the outstanding balance at the year end is subject to corporation tax at 25%, commonly known as s455 tax. When the loan is repaid the s455 tax becomes repayable to the company after nine months and one day following the end of the accounting period in which the loan is repaid.
However, if a repayment of the loan is made within nine months and one day of the accounting period in which the loan was made, relief can be claimed, in that accounting period, for the amount of loan which has been repaid.
Anti-avoidance rules surrounding loan repayments ‘Bed and Breakfasting’
It is not uncommon for loans to be advanced in an accounting period, then repaid by the director shareholder nine months after the end of the period thus avoiding the tax charge, only for a new loan to be advanced shortly afterwards. This is a process or activity known by the Revenue and tax profession as ‘Bed and Breakfasting’.
In order to prevent the misuse of this relief and ‘bed and breakfasting, the government introduced legislation to deny the tax relief for temporary repayments of loans to participators . The measures introduced to counter the abuse are as follows:
Where repayments totalling £5,000 or more and new loans totalling £5,000 or more are made within a 30 day period, the repayments will be treated as repaying the new loans rather than any earlier loans.
Arrangement rule (outside the 30 day period)
This rule will apply where any outstanding loan exceeds £15,000 before applying the repayment and if at the time of repayment arrangements have been made whereby at least £5,000 of new loans is to be made. If the new loans haven’t already been matched with a repayment under the 30-day rule, the repayment is matched to the arranged new loans.
An arrangement in this context is not defined but will be interpreted widely by HMRC and will cover any steps taken by the borrower, a third party or the company for the new loan to be made after the repayment. For example, a director could arrange with a bank to borrow from a personal savings account temporarily and use this to repay the loan before taking out a new loan from the company at a later date. Evidence to prove this arrangement may come in the form of board minutes, bank statements, correspondence/ notes of interaction with bankers, both for the company and the participators.
It is important to consider these additional restrictions and how they may prevent relief for loan repayments that would previously have been eligible. HMRC are seeking to apply these rules so it is important that care is taken when claiming relief as an incorrect claim can render the company liable for tax geared penalties for the submission of an incorrect tax return.
Tax implications of writing off the loan
If a company writes off or releases a loan to a participator, the company will receive a repayment of the s455 tax paid in respect of this loan but will not get a deduction for this in the company tax return.
The loan written off will be taxed as a dividend for income tax purposes and as earnings for NIC purposes, therefore subject to class 1 employees and employers NIC.
Any taxable benefit arising on a loan to a director will be reported on the P11d for that tax year.
Any s455 tax arising as a result of a loan advanced in an accounting period will be reported as part of the company tax return but any claim for a repayment of s455 tax must be made separately from the tax return and can only be submitted to HMRC when the repayment is due (nine months and one day following the end of the accounting period in which it was repaid).
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