Friday 16th January 2009 Blog

Overdrawn Directors Loan Account Issues

If your client borrows funds from their own company or gets it to pay personal bills on their behalf, there could be additional tax bills for both them and their company unless they repay that money to the company quickly.

- Personal Tax
Where the amount they owe to the company exceeds £5,000 at any time in the tax year, and they have paid interest at less than the official rate on this loan there will be an income tax charge on them personally. The official rate has been set at 6.25% since 6 April 2007 in spite of the massive cuts in the Bank of England interest rates since then.

- Corporate Tax
Where the loan is still outstanding nine months after the company's year end the company has to pay a tax charge equivalent to 25% of the loan, known as a 'section 419' charge. When the loan is eventually cleared this section 419 charge can be reclaimed by the company, but only when its next corporation tax bill is due.

- What to do
If they do owe their company a significant amount they could either:

1. Use other personal funds to reimburse the amount they owe; or
2. Get the company to pay them a dividend or a bonus that is set again the loan to bring the amount they owe back to zero; or
3. Ask the company to write-off the loan.

- Implications
Option 1 creates no further tax charges for them or their company, so it's the best in that respect.

Option 2 generates more tax for your client, particularly if they already pay higher rate tax. In that case they will have to pay 25% of the net dividend in tax but they won't have received a cash dividend to give them the funds to pay that tax. The company may have to pay them a higher dividend to give them enough cash to pay the higher rate tax due. The company must deduct PAYE and NICs from any bonus it pays, so can often be more expensive and it must have the cash to pay that tax and NI to the Taxman.

Option 3 the loan write-off, is treated as a distribution by the company at the date of the write-off. This is taxed as a dividend in your client’s hands, complete with the 10% tax credit, but it is not actually a dividend. The company cannot claim a deduction against corporation tax for the amount of the loan written-off. The Taxman may also argue that NI contributions are due on the amount of the released loan, as if it was a payment of salary.

Posted by: Bookcert Mentoring Team

Friday 16th January 2009

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