Posted by James Pearson on 05 Jul 2013

Directors Loan Accounts

When a close company makes a loan to a participator (shareholder) which is outstanding at the accounting year end, HMRC charges the company to tax at 25% of the value of the outstanding loan. This is to discourage lending to directors (which is otherwise almost free from income tax) instead of taking a salary or dividends. The 25% tax charge is repaid by HMRC 9 months after the end of the accounting period in which the loan is repaid or written off.

For many years this charge has been easily avoided because as long as the loan was repaid within 9 months of the accounting year end the 25% charge was not due. This meant a participator could theoretically pay back the loan the day before the tax charge was due and then withdraw the whole amount as a new loan without any tax consequences. This tactic was known as Bed and Breakfasting. In some cases HMRC has attacked such arrangements as a sham, arguing that realistically no loan repayment was made, but the basic principle has been used as the basis of increasingly subtle arrangements.

Bed and Breakfasting

Bed and Breakfasting is now being targeted by HMRC and new legislation has taken effect on loans outstanding from 20 March 2013 onwards.  If within a 30 day period, there are repayments of an outstanding loan, and new loans are taken, HMRC will limit the relief available from the 25% tax charge. If the repaid loan is fully replaced by another loan within the 30 day period, no relief will be available. It should be noted that where the repayment of the loan incurs an income tax liability (for example if a dividend is declared that is used to repay the loan) HMRC will not attempt to restrict relief.

This legislation is extended for loans in excess of £15,000 by removing the 30-day time limit and replacing it with a “motive” test. If there is an intention for a fresh loan to be made then the repayment of an existing loan does not qualify for relief, regardless of whether the new loan is made within 30 days. It is possible that HMRC will argue that where there is a pattern of loans being repaid only to be replaced, there is an intention to replace the loan and therefore relief is not allowed. As above, if the loan repayment incurs an income tax charge, that element of relief is allowed.

So what can be done to manage this situation?

  • Planning is key. Get your journals and books to us as soon as possible following the year end. This will give us more time to be able to prepare your accounts and manage the director’s loan account situation.
  • If you normally withdraw funds “in anticipation” of a dividend, consider taking a monthly dividend in advance so the loan account is always in credit and there will not be any nasty surprises.
  • Consider moving your company to quarterly management accounts so you can make sure there are no surprises around the corner and your company is providing you with the most tax efficient distributions.

Tax Innovations

If you would like any advice regarding the above article or would simply like to discuss other ways in which we could help you or your business, please contact us on 01962 856 990 or customerservice@taxinnovations.com.