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This podcast selection is taken from a series of Business Hub radio shows broadcast on Star FM between February 2011 and October 2014 with advice from basic book-keeping through to crowd funding, directors loans, cashflow and a whole lot more!

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Business Trouble - your choices

Directors Loans - Some Important Changes

The Business Hub Show - 13 August 2013

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Mark

We are talking Directors Loans this week then!  Something I am always interested in!!

Garry

Yes, it is rather a nice idea isn’t it – borrowing money from your company!  Unfortunately the Tax Man does not agree it is such a good idea and has some pretty penal measures relating to overdrawn Directors Loan Accounts – that is accounts where you owe the company money.

We have covered this before, but I thought it was worth revisiting as there have recently been some changes in the rules designed to stop abuse of the system.

Mark

So why is it an issue owing money to your company?

Garry

It is an important principle that as a business owner operating through a Limited Company, you and the company are quite separate. In fact in law you are separate legal persons. Therefore if you extract any income from your company it must be declared as income and therefore paid either as salary through payroll, where tax and national insurance will be deducted, or as dividend which will also attract a tax charge.

By drawing a loan through an overdrawn Directors Loan Account you are in effect avoiding these two routes, and it is that that the tax man takes a dim view of.

As a result it has been the case for some considerable time that if you have an overdrawn Directors Loan Account at the end of your financial year this must be declared on the Company’s Corporation Tax return, and if it is not repaid within 9 months of the year end it attracts a tax charge of 25% of the amount outstanding.

This amount is in fact refundable should it be repaid in the future.

Mark

So how do you solve this?

Garry

Simple – don’t have an overdrawn account!   Either repay it, or process a salary payment through payroll and pay the tax and national insurance, or declare a dividend, and offset the amount outstanding. As both of these are properly taxed there is no issue, however it is not considered good practice to build up an overdrawn Directors Loan Account and then declare a dividend and this practice is best avoided. The reason being that your company may not have sufficient distributable reserves to pay the dividend from when the time comes – for instance if it has become loss making.

It is a very common issue that amounts are built up through a Directors Loan Account and then the company is not in a position to “repay” the loan by paying a salary or a dividend, so it is critically important that you constantly monitor the position through the year with up to date and reliable Management Accounts.

Mark

You mentioned there have been some changes

Garry

Yes, indeed. It was seen to be becoming practice for Directors to repay their overdrawn Directors Loan Accounts just before the year end and then draw the money again immediately after to prevent the tax charge. You could also do the same thing in the 9 months after the year end, as I mentioned above.

The new HMRC rules from 20th March 2013 are designed to prevent this, as now if at least £15,000 is outstanding before a repayment and at that time there is an intention to re-borrow from the company, and that intention is carried out, the amount repaid is ignored and the result is a tax charge.

Whilst it is not entirely clear yet, it appears that this intention might be assumed if the amount or a similar amount is re-borrowed within a short period of time after the repayment. There is not yet any clear direction on what is meant by a short period, and I suspect as with all these rule changes it may take a little while for it to filter through how it works in practice.

The impact is to most likely stop Directors abusing the process as has become quite common.

A further point worth noting, finally, is that these rules actually technically relate to participators loans in close companies. A close company is one controlled by five or fewer people, and participators includes shareholders as well as Directors and others closely associated with the business.

 

 

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