Seeking to improve cashflow via a director’s loan? ACCA share this helpful guide around Issues to consider around directors’ loans when advancing funds to help improve business cashflows.
Due to the effect of Covid, directors of an owner-managed company might be required to advance funds via a ‘director’s loan’ to help improve the cashflow of the business.
Below are some of the issues that directors should consider.
It is not mandatory to have a written loan agreement in place, but it is always advisable to formally document a loan arrangement. The agreement should include the interest rate (or range of rates) and repayment date (or range of dates).
The loan can be interest free or charged at any agreed rate but if it exceeds the ‘arm’s length’ rate, there is a danger that the excess may not be allowable as a tax deduction against corporation tax for the company.
What is ‘arm’s length’ is determined by reference to the commercial interest rate charged by a third-party lender, taking into account the size and term of the loan as well as the risk profile of the company.
Interest charged by the director to the company on the loan is usually an allowable business expense for the company. However, if the funds provided aren’t used for the purposes of the company’s trade, the interest will not be tax deductible.
Income tax deducted by the company on interest payments
If the loan term lasts for longer than a year, the company must deduct basic rate tax from payments of ‘yearly interest’ made to an individual.
Companies must account for income tax on a quarterly basis, using a CT61 quarterly return, based on amounts paid and received in the particular quarter.
The main provisions covering CT61 returns are contained in Part 15, Chapter 15 of the Income Tax Act 2007.
The quarter-ends are based on the normal calendar year, ie 31 March, 30 June, 30 September and 31 December. However, if a company’s year-end does not fall on any of these dates, the balance sheet date is also deemed to be a quarter-end, so there will be five return periods.
Further guidance on CT61 returns can be found here.
1. Interest received on a loan given to the company counts as personal income for the director and must be reported on the director’s self-assessment tax return and taxed accordingly. If the company has retained tax (on the ‘yearly interest paid’) credit would be given in the usual way. See also our article on year-end planning for some tips.
2. An individual who borrowed money in order to lend it to the company is entitled to relief for the interest paid on that loan provided that he/she:
- works for the company and owns some of the ordinary shares (the full-time working condition), or
- holds at least 5% of the share capital, taking into account shareholdings of ‘associates’ (the material interest condition), and the loan is a ‘qualifying loan’.
A loan is a ‘qualifying loan’ if:
- it is used to acquire ordinary shares in a ‘close company’ that is not a ‘close investment-holding company’ or
- it is lent to such a company and used wholly and exclusively for the purposes of the business, or
- it is used to repay another qualifying loan.
No relief can be claimed for interest on overdrafts or credit cards.
From 6 April 2013, the total amount of qualifying loan interest relief that can be used to reduce a person’s total taxable income is limited to £50,000, or 25% of their adjusted total income if higher.
Further guidance on qualifying loans can be found here.
3. If the loan becomes irrecoverable, capital loss relief may be available in accordance with S253 TCGA 1992 under the rules for relief for loans to traders.
Relief may therefore be claimed against capital gains of the year of claim or carried forward to the first available gain(s) of subsequent tax years. However, the legislation also permits a claim to specify an earlier date, not more than two years before the tax tear of the actual claim, provided that the amount was also irrecoverable at that earlier date.
Further guidance can be found here.
This article has been shared from ACCA In Practice, to whom copyright belongs. Whitefield Tax are an ACCA Member Firm