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During an accounting period, a director may take funds from the company to maintain their director’s loan account (DLA). Withdrawals may be met by salary, bonus, dividends (dividends are preferred since no NICs are due), or by repayment. However, towards the end of that period, the director may have borrowed money from the company (typically without interest) and not repaid it, resulting in a debit balance on the DLA. If there aren’t enough retained earnings to pay a dividend or if the amount isn’t repaid, there may be tax ramifications. If no retained earnings exist, a bonus may be paid in instead of a dividend.
Close company rules should apply to loans to participators (including directors) that are not repaid nine months and one day after the year-end in which they were taken out (the usual corporation tax due date). The ‘section 455’ charge is 32.5 per cent of the loan amount (equivalent to the higher dividend tax rate). The practice of replacing overdrawn funds shortly before the due date (thereby avoiding the § 455 tax charge) and withdrawing the funds soon after (known as “bed and breakfasting”) was widespread before 2013. In this approach, the director may get an interest-free loan for years. So HMRC intensified the rule by imposing limitations on loan repayments of at least £5,000 repaid by new loans of at least £5,000 within 30 days. The repayments are matched against the subsequent loans, thus meaning no repayments have been made, and the s 455 tax charge on the initial loan amount stands. The s 455 tax is refundable if the loan is repaid within nine months and one day after the end of the accounting period.
A s455 loan of £15,000 or more triggers an extra provision. In this case, the repayment will be ‘matched’ against the new charged payment rather than decreasing the old section 455 charge. Just like with the 30-day rule, this clause does not apply if the repayment is made by way of a bonus or dividend, which is taxable. Deferred tax charges do not apply when a bonus payment (payable through PAYE/NIC) is used to fully clear an overdrawn DLA before the due date for corporate tax. HMRC agrees that crediting an interim dividend to a loan account is ‘payment’ since the amount is ‘placed unconditionally at the disposal of the directors/shareholders as part of their current accounts with the firm’.
What happens if Director cannot pay loan back to company?
If a director cannot repay the loan and the company cannot pay a dividend or bonus, the company may delay the section 455 charge by shortening the accounting period. The repayment date is now nine months following the accounting period’s end. If the loan is still due at the end of the accounting period but paid off before the trigger date, it must be reported to HMRC.
If a close company (one with fewer than 5 participators) writes off a director’s loan – on the event that the director is also a participator. The loan is described as a profit distribution in this context. If the loan is not paid to a participant, the remaining amount is taxable as employment income and reported on the borrower’s tax return. For reasonable reasons, personal liability from a director’s loan may be reduced i.e., travel expenditures or personal expenses utilised to acquire assets for the company. The DLA may be reduced by voting the remainder as a dividend or bonus – albeit this will not work if the company is headed into insolvency
The liquidator will demand that directors repay their debts to the company for the benefit of the creditors. Even in the event of personal bankruptcy, directors who fail to make this payment might be held accountable by legal action. Your personal means may need to be discovered by the liquidator to decide whether you cannot afford to repay the loan. It is a liquidator’s job to guarantee the loan is repaid. Personal bankruptcy may be your only option if you are unable to repay the debts you owe. In addition, the insolvency practitioner has a responsibility to examine your actions as a director prior to the insolvency or the lead-up to the liquidation of the company. This might result in a 15-year ban from becoming a director of any company.