Loans to Directors of small companies
October 2006 Tax Newsletter
Small company accounts often show an overdrawn position on directors loan accounts. Technically a company cannot loan funds to a director, this is a breach of the Companies Act. Fortunately, for private companies, this apparent breach of the law is not subject to criminal sanctions.
Where the amount of the loan exceeds £5,000 it is good practice to get the written permission of the shareholders to the granting of the loan - unless the director is also the sole shareholder.
The loan will have a number of tax consequences. Two are highlighted below.
S419 Corporation Tax
If a small company had loaned say £10,000 to a director and this amount was unpaid at the year end, 31 December 2006, then an additional corporation tax charge could be created. Whether the tax would fall due depends on when the loan is repaid.
If the loan is unpaid 9 months after the year end, 30 September 2007 in the above example, the Revenue would issue an assessment based on 25% of the loan, £2,500, which would be payable on the 1 October 2007. This is not a permanent loss of revenue for the company as a claim can be made to have this £2,500 refunded when the loan is paid back to the company. Unfortunately the refund of tax will be delayed until the due date for corporation tax in the trading period in which the directors loan was repaid.
In our example above if the loan is paid back in full on the 30 November 2007, and as this is after the 9 month cut off (30 September 2007), the additional tax would have to be paid on the 1 October 2007. As the directors loan was cleared in the trading year to 31 December 2007 the refund of £2,500 would not be forthcoming until the 1 October 2008.
This provision applies to all loans outstanding at the accounting year end, even those under £5000.
As you can see from this example the timing of repayments of the loan is critical.
Directors' personal tax
The grant of a loan by the company to a director is deemed to benefit the director and not surprisingly the Revenue will want their pound of flesh.
There are two possible outcomes.
- 1. If the company charges the director interest for the term of the loan the Revenue will not seek to assess the director for any additional benefit. The rate of interest charged must be at least the official rate of 5%. This will increase the company's taxable profits by the amount of the interest and will of course increase the amount that the director has to pay back overall.
- 2. If the company does not charge interest or charges at less than the 5% official rate, the Revenue will assess the deemed shortfall in interest, which they consider should have been charged, as a benefit in kind. This will need to be returned on the form P11D at the tax year end. The current rate of interest applied is 5%.
Please note loans to individual directors that do not exceed £5000 at any time during the relevant year will not attract a benefit in kind charge.
