We are calling for Leicestershire businesses to watch out in regard to directors’ loan accounts, as this is an area of limited company operations that tends to trip up businesses during tax return reviews. Here we set the record straight on how businesses can reduce the risk of being caught out.
What is a director’s loan account?
A record of cash and non-cash transactions between a limited company and its director(s). This includes cash withdrawals and money not used exclusively for business purposes, and usually excludes salaries and dividends.
HMRC often finds errors relating to directors’ loan accounts in company tax returns – why is this?
If a full record of cash and non-cash transactions is not kept, or if the director has a limited understanding of the rules surrounding this area of a company’s accounts and taxes, errors can occur.
Why is a comprehensive record of all transactions essential?
At the end of the financial year, the director will either owe money to his or her company or be owed, constituting either an asset or a liability. If money is owed by the director and the company is owned by five shareholders or less, tax consequences will apply.
Assuming a director owes his or her company at the end of the tax year, what tax consequences are there to bear in mind?
If a director’s loan account is overdrawn at the end of the financial year and remains overdrawn for longer than nine months and one day after the end of this accounting period, a company tax charge calculated as 32.5% of the loan amount will arise. This will be available for refund nine months following the end of the accounting year in which the loan is repaid.
How can the charge be avoided?
Provided the loan is cleared before the nine months and one day cut-off described above, the tax charge can be avoided. This can be achieved by the director paying funds into the company, or by the company declaring a dividend, paying a bonus or crediting the director’s salary to the loan account, all of which can clear the loan balance.
What needs to be considered when clearing the account?
The dividend, bonus payment and director’s salary options described above will all incur separate tax bills. It may also be the case that paying the tax charge would cost less than clearing the loan, e.g. if a bonus was taxed at the higher rate, or if the National Insurance on a salary made it higher than the loan balance. Once repaid, however, the 32.5% tax paid by the company will be refunded by HMRC.
Partner John Griffin says: “With various tax implications and potential charges to consider, it pays for businesses and their directors to ensure they have a good grasp of their director’s loan account throughout the tax year.
“Keeping regular and consistent records of all transactions – cash and otherwise – is the best and most straightforward way to prevent mistakes from happening.”