This Content Was Last Updated on February 9, 2017 by Jessica Garbett
Worked examples illustrate how to clear an overdrawn director’s loan.
The most common way of clearing an overdrawn director’s loan is by way of a dividend (interim or final).
However, if the company has insufficient distributable reserves available, the following options are available:
1. Leave the amount outstanding as an overdrawn loan.
2. Pay a bonus which would clear the amount of loan outstanding.
3. Write off the loan.
The tax implications of each of these options are best illustrated by way of an example:
Mr Hector is the director of company A Ltd. He receives a wage from the company which covers his personal tax allowance. At the end of the year, Mr Hector has an outstanding overdrawn director’s loan account of £10,000. A Ltd does not have any distributable reserves.
Option 1: Leave the amount outstanding as an overdrawn loan
If the director’s loan has not been repaid nine months after the balance sheet date, then a charge will arise under section 455 CTA 2009.
The amount of tax payable by a company under section 455 is 25% of the lower of the amount outstanding at the balance sheet date and nine months after the year end. In this example, the tax payable by A Ltd would be £10,000 x 25% = £2,500.
Under current legislation, this is not a permanent tax. The tax which a company pays under section 455 will be repaid by HM Revenue & Customs nine months after the end of the accounting period in which the director’s loan is repaid.
If the loan made by a company to its director is interest free and the amount is outstanding for a whole year, a benefit in kind will arise.
The benefit in kind is calculated as interest at the official rate (currently 4%) of the average amount of the loan. In this example, the benefit in kind would therefore be £10,000 x 4% = £400.
The company pays Class 1A NIC on the benefit at 13.8%. In this example, the amount of Class 1A NIC payable by A Ltd would be £55.20.
The director will have an additional tax liability on the benefit in kind. In this example, Mr Hector’s additional tax liability would be £80 (being £400 x 20%, assuming that he does not have any income other than the wages he receives from A Ltd), collected via self-assessment.
Total tax due is therefore:
Section 455 tax 2,500.00 (temporary tax payable by A Ltd)
Class 1A NIC 55.20 (payable by A Ltd)
Tax on the benefit in kind 80.00 (payable by Mr Hector)
Option 2: Pay a bonus which would clear the amount of loan outstanding
In this example, the amount of the net bonus would be £10,000, in order to clear the overdrawn director’s loan account.
This net amount would be grossed up in order to take into account basic rate tax and employee’s NIC. £
Gross pay 14,705.88
Total tax due is therefore:
Employee’s NIC 1,764.70
Employer’s NIC 2,029.41
Less corporation tax relief (20%
of gross pay plus employer’s NIC) (3,347.06)
In order to avoid the section 455 tax liability described in option 1, above, such a bonus must be processed by the company within nine months of the balance sheet date, otherwise the loan remains outstanding.
Option 3: Write the loan off
The amount of the director’s loan which is written off is treated as a dividend for income tax purposes, but not for accounting purposes.
Accordingly, employee’s and employer’s NIC contributions would be payable on the amount of the loan written off.
In this example, the amount of the director’s loan account written off would be £10,000. The gross dividend assessed on Mr Hector would be £11,111
Total tax is therefore:
Director’s tax liability (basic rate taxpayer) Nil
Employee’s NIC 1,200
Employer’s NIC 1,380
Less corporation tax relief on employee’s
and employer’s NIC (516)
In this example, from a tax perspective, writing off the director’s loan therefore appears to be a cheaper option than paying a bonus.
Importantly, if a company is insolvent (unable to meet all of its current liabilities) making the decision to write off the director’s loan should only be made after seeking legal advice.
At Budget 2013 the government announced its intention to consult on options for reforming the rules which govern extractions of value, usually as loans or advances, from close companies. The consultation period took place between July and October 2013 and the responses received are intended to assist in the design of reforms to the current rules with a view, if appropriate, to revised legislation in Finance Bill 2014.
Post contributed by ACCA