by Dorothy Scott FCCA
There are tax consequences associated with directors owing amounts to their companies – both corporation tax and income tax. With the end of the tax year upon us and the financial year-end for many companies, this would seem like an appropriate time to remind you of good practice in this area.
It is important that directors and companies keep their finances separate.
In general directors’ drawings from a company should be either in the form of remuneration (through payroll) or dividends. The company’s financial records need to properly record the nature of any payments to directors.
Directors should avoid ad hoc payments for personal expenses being made by the company, and this includes income tax and national insurance. The exception to this is where there is a credit balance due to the director by the company against which such payments can be offset.
Dividends
A company needs to have distributable profits in order to pay dividends. The directors need to be confident that this is the case before any dividend payments are made. This, in most cases, would be with reference to monthly or quarterly accounts. In evaluating whether a company has distributable profits directors also need to consider the seasonality of results and corporation tax payable.
If a company makes dividend payments in excess of distributable profits they are deemed to be illegal dividends and there are tax consequences. This situation should be avoided.
In a company’s accounting records dividends should be recorded as such and posted to a dividends account, not reflected through a directors loan account.
Dividend payments should be made in line with shareholdings.
Remuneration
Where a company is not profitable, perhaps in the early stages, it does not have distributable profits to pay dividends and therefore any drawings made by directors would have to be in the form of remuneration. Equally if a company is not able to demonstrate at any point in time that it has distributable profits it would be prudent for drawings to be taken in the form of remuneration with a dividend perhaps being paid once the results were available.
In a company’s accounting records remuneration should be recorded as such and posted to staff costs, not reflected through a directors loan account.
In practice, for the majority of small companies, directors’ drawings will be a mixture of remuneration and dividends.
It should be noted that there are pension benefits from drawing remuneration.
Directors Loan Accounts
For many companies, loans from directors are a vital source of funds when the business is initially established and there are no tax consequences of a director putting funds into a directors loan account. When the business has grown and cashflow permits, the directors can withdraw these funds, again with no tax consequences.
However there are tax consequences of a director owing funds to a company:
Income tax/ National insurance
A tax benefit can arise, as a benefit in kind, when at any time during the year a director’s loan exceeds £10,000 (£5,000 up to 5 April 2014). The benefit is calculated at an HMRC official rate of interest (currently 2.50%), less any interest actually charged, and income tax at either 20% or 40%, or at Scottish tax rates of 19% (starter), 20% (basic), 21% (intermediate), 41% (higher) or 46% (top) is payable along with Class 1A National Insurance at 13.8%.
The benefit is generally calculated using an averaging method or HMRC can request a precise calculation.
The company needs to report the benefit in kind on form P11d and pay Class 1A National Insurance. The benefit in kind also needs to be included by the director on their personal tax return.
Corporation tax
An S455 tax charge is payable on any loans to directors (or other participators) which is not repaid within 9 months of the year-end. S455 tax is calculated at 32.5% of the outstanding balance and is payable with the company’s corporation tax. The S455 tax is repayable but there is a time delay, with repayment being 9 months after the end of the accounting period in which the loan is repaid. These loans cannot be bed and breakfasted to avoid the S455 tax charge, i.e. repaid within 9 months and then advanced again.
To avoid these tax charges and the additional paperwork involved, it is best to avoid directors loan accounts becoming overdrawn, i.e. directors owing funds to the company.
We strongly recommend that directors and companies keep their finances separate. When the company account is routinely used to pay personal expenses for directors things get messy.
Key Points
- Overdrawn directors loan accounts should be avoided as there are negative tax consequences.
- Proper record keeping is important. Clearly differentiate between remuneration and dividends.
- Company bank accounts should not be used to pay directors’ personal expenses.
And Finally…
This is intended to be an overview. The rules in these areas are detailed and complex, so if any of these issues affect you please get in touch.