When operating as a sole proprietorship or partnership, it is typically simple and quick to withdraw money for personal use, and there are typically no tax repercussions until proprietors’ draws represent a significant drain on the firm’s assets.
However, since a corporation is a separate legal entity, any loans it makes to its participants (directors and shareholders) should be carefully thought out and planned.
In this article, we examine the effects of an overdrawn director’s loan account in further detail, as well as the ramifications of a corporation owing a shareholder money.
Since March 31 is a common date for corporation accounting, many firms will be considering final dividend payments. This might be crucial for nearby businesses since there can be overdrawn loan accounts to take into account. In this post, we examine the important factors.
Final dividends, as opposed to interim dividends, are distributed when the company’s accounting period’s books are authorized and a precise estimate of the cumulative profit can be made. While final dividends must be authorized by the shareholders, often at the AGM, interim dividends may be announced by the board of directors alone.
Naturally, the directors and shareholders of a close firm (one controlled by five or fewer participants) are likely to be the same individuals. Private firms are no longer required by law to conduct an annual general meeting (AGM), and in reality, close companies’ dividend payments will only be approved in writing. However, there can be additional factors involving nearby businesses that warrant more examination.
It is “common knowledge” that a special tax charge under CTA 2010, s. 455 may be incurred if a director owes money to a close firm. This isn’t really true because the director must also be a shareholder and the fee only apply to participators. Additionally, when a participant has less than 5% of the voting rights, no fee will apply if they owe the firm or any connected companies less than £15,000 and they are employed full-time by the company (or affiliate).
Where s. 455 is in effect, the corporation is subject to the 33.75% fee. While paying interest on the outstanding balance can eliminate an income tax charge, this cannot be used to evade the charge. This is a one-time charge that can be fully or partially recovered when the loan is returned, but not until nine months have passed after the end of the repayment term.
The fee is determined as part of the filing of the corporate tax return; the corporation tax payment deadline is also nine months. 455 only comes into play when a participator owes money at the accounting date and that money isn’t paid back within nine months. To determine the exposure to the charge, it is necessary to analyze the loan account balances for the directors. The next step is to decide what course of action to take. If paying the fee isn’t the best course of action, for example because of cash flow, there are generally two options:
In order to reduce the fee, either the participant repays all or part of the debt, or the balance is waived and wiped off.
A participant might simply deposit money into the business’s bank account, with the amount being deducted from the balance and credited to the DLA. However, given the individual’s circumstances, it might not always be achievable. It could be tempting to take out a second loan to raise more funds to pay off the current sum, but doing so could violate anti-avoidance regulations.
Alternately, the business might issue a final dividend, providing the borrower money to pay back the loan, although it could be hesitant to do so if it worries about its cash reserves, especially in light of this year’s hike in the corporation tax main rate. If the sum previous to repayment was at least £15,000 and future amounts are borrowed if there were “arrangements” to borrow at least $5,000, this is also likely to violate the anti-avoidance regulations. Both CTM61630 and CTM61635 cover the rules. The regulations basically overlook all or a portion of the repayment for calculating the s. 455 fee.
However, a ‘cashless’ repayment might be done by debiting the DLA of a bonus or dividend to pay off the amount. The benefit of this is that it totally avoids the anti-avoidance provisions, as HMRC at CTM61642 confirmed:
This law does not apply in cases when the repayment itself results in a tax liability for the participant or associate who received the original loan. This may occur, for instance, if the loan is repaid by the crediting of a dividend to the loan account that is reported as income on the recipient’s tax return or the payment of a bonus that is subject to PAYE/NIC before being credited to the loan account.
The participant would undoubtedly owe income tax as a result of this, but because the anti-avoidance regulations do not apply, additional borrowings from the firm can be used to pay for this without incurring an s. 455 charge until the following year, when the practice can be repeated. This might fully minimize the borrowings over a period of time.
Using a dividend will often be more effective for this, but it is essential to make sure there are enough earnings to do so. If not, partial dividend payment with the difference made up by “paying” a bonus and crediting the sum to the loan account will also function. However, keep in mind that this will affect PAYE and that the loan account will only be credited using the remaining funds after NI and tax.
When a participant is terminating relations with the firm and is not in a realistic position to make good on the debt, the corporation may also elect to write off the remaining balance. This may also imply that Section 455 does not apply or that any amounts already paid may be returned, but it is crucial that this be done properly.
The s. 455 issue is not resolved if the debt is just wiped off because this does not renounce the right to receive payment. The loan must be properly released (waived) in order to avoid the fee, which may be accomplished with a straightforward deed. Additionally, a board minute must be recorded. It should be noted that this instantly discharges the participant’s duty to pay, making it impossible to pursue them for payment if their situation changes in the future.
The departing participant will subsequently be charged as though they had received a dividend in an amount equal to the sum the corporation has waived. It should be noted that although if the tax treatment resembles a dividend, the discharge of the loan will be recognized as earnings for Primary and Secondary NIC purposes. For the month the debt is forgiven, this must be paid via the PAYE system. The amount written off cannot be deducted from the company’s taxable earnings under CTA 2009, s. 321A.
It should be noted that the amount will be recognized as earned income rather than a dividend when a loan to a director or employee who is not a participator is discharged.
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