Overdrawn directors loan accounts

Shareholders who owe the company money that they are shareholders in have what is commonly known as an overdrawn loan account. Strictly speaking these are called Loans to Participators.

There are two tax consequences of such loans:

  1. A personal tax charge, being a benefit in kind, based on the official rate of interest (currently 4%) on the average balance in a tax year. The company also incurring an employer National Insurance liability, and
  2. A company tax charge of 25% based on the outstanding balance at the end of the accounting period (this can be mitigated by clearing the outstanding balance within nine months of the year end). Where loans are cleared at a future date any tax already paid can be claimed for a repayment. This is often known as s455 tax.

S455 tax has recently come under scrutiny from HM Revenue & Customs in two respects.

Firstly, some “bed and breakfasting” provisions were introduced in the Finance Act 2013 in order to prevent loans being repaid prior to the nine month cut off, only to be redrawn shortly afterwards. This prevents non-payment of this tax and also prevents tax already been paid being repaid, only to fall due again in the next accounting period.

Quite often, such loans are cleared by declaring bonuses or dividends and as these are taxed on the recipient this will continue to be allowed and the “bed and breakfasting” anti-avoidance provisions will not bite.

  • Secondly, a consultation has been issued to revise s455 tax further. Options included in the consultation are:
  • Increasing the rate to, say, 40%
  • Moving to a non-repayable annual charge of, say, 5% based on year end balances (nil tax if cleared within the usual nine month period)
  • Moving to a non-repayable annual charge of, say, 5% based on average balances regardless of whether the loan is subsequently cleared.

At the moment this is just a consultation but it is likely change will occur in April 2014. Worryingly, HMRC consider this to be tax avoidance whereas, in reality, most affected companies are in this position as owners of the companies used to operate as sole traders or partnerships and do not understand the legal status of a company. This is not deliberate tax avoidance.

It remains to be seen the outcome of the consultation and Armstrong Watson has submitted their response here. We will keep you informed of the outcome.

Nigel Holmes, Director - Corporate Tax

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