Directors who are running their own company sometimes blur the distinction between the company’s money and what they consider to be their own money!
So sometimes you find the director will use the company money as though it was their own personal account and take lump sums out whenever suits their needs.
The problem with this is that come the company year end when the accounts are prepared there may be a very large overdrawn directors loan account to resolve.
If this is not dealt with then the company will need to pay corporation tax. This is tax on the “loans to participators” rules which will result in 32.5% being paid on the outstanding amount. This tax is repaid to the company when the loan has been repaid by the director.
If the director is also a shareholder, then the usual situation is to declare a dividend to remove the overdrawn position and therefore the “loans to participators” tax will not be due. This is generally more tax efficient than providing remuneration as it would be subject to employees and employers national insurance.
However, what is the situation if:
- The company does not have sufficient reserves to declare a dividend?
- There are other shareholders?
If there are other shareholders and for example, say there are 4 shareholders each owning 25% of the shares. Then if one director/shareholder is overdrawn by £100,000 then a dividend of £400,000 would need to be declared! This will have tax consequences for all the other shareholders. You may be able to change the share classes but the other shareholders may disagree to this.
If the company declared a dividend and there were not sufficient reserves, then HMRC could argue that the director effectively owes this amount back to the company and therefore the tax on the “loans to participators” will still be due
So, is there a solution?
You could consider writing off the loan
The rules relating to loans to participators state that if the loan is written off, it is to be treated as a dividend, without actually paying a dividend
HMRC may try and argue that the loan was made for the reason of their employment and try to treat the write off as remuneration. However, it could be argued that the rules state where there is such a loan write off which could be argued to be earned income or a dividend, then it is the dividend basis which prevails.
So if you are caught between a rock and hard place and you only option is to write off the loan you may be able to treat this a dividend. But, be aware HMRC may well challenge your treatment of it!
It is always important before you take any action that you obtain professional advice. If you have any questions in respect of the above, then please do not hesitate to contact our tax experts by sending an email to email@example.com