This article explains Director's Loan Account (DLA), s.455 penalty tax and consequences
Key words: DLA, Participator, Interest, S.455 Tax, Credit Balance, Debit Balance, Overdrawn, Written-Off, Consequences and Mitigate.
This article explains DLA, interest, s.455 penalty tax and what the consequences are for the company and the directors/participators in the UK. Also, how to mitigate the overdrawn DLA is explained.
DIRECTOR'S LOAN ACCOUNT (DLA)1
A director's loan is when a director (or other close family members) gets money from the company, other than a salary, dividend or a loan repayment.
Sometimes a director lends money to the company, as a way of start-up costs or as supportive when a company is in cash-flow needs. As a result, the director becomes one of the company's creditors. When the company is borrowing more money from its director(s) than it lending to him, then the director account is in credit.
There are also occasions where the director(s) borrow money from the company, as a way of cash draw for personal use and to pay unexpected bills or even for personal expenses. In case the director(s) borrow more than lending to the company, then the DLA will be overdrawn.
In other words, the DLA is where a track is kept of all the money the director either borrows from or lends to the company.
Another important thing to mention is that any borrowings of the director(s) from the company needs to be paid back. It is not allowed that director(s) use company's money as an emergency personal funds, as there is a risk of potential penalty tax (s.455 tax) for this. Besides that, any creditor and/or shareholder will become concerned when the DLA is overdrawn for a longer period of time.
INTEREST ON DIRECTOR'S LOAN
Credit balance on DLA
Director(s) can charge interest to the company on the credit balance of the DLA. This interest is deductible expenses for the company, When the company is paying interest to the director(s) who is an individual, the company is required to deduct basic rate income tax (currently 20%) at source and pay over to HMRC. Note that, this is a taxable income for the director(s),and needs to be declared on his self-assessment tax return. Individual directors will receive credit for income tax deducted at source in their personal tax computation as usual, which is deducted from the tax liability at the end of the tax computation.
Overdrawn or debit balance on DLA
The company can charge interest on a director's loan if its overdrawn. The company will receive interest from the individual, net of basic rate tax at 20% at source. However, if the interest charged is same as the market rate or equal to the HMRC official rate then no benefit in kind will arise for the director. However, if no interest has been charged or interest rate is below the HMRC official rate, then benefit in kind will arise for the director. This means that the director will be taxed on the benefit and reported to director self-assessment tax return. The company needs to submit P11D to HMRC to report this loan benefit and Class 1A NIC on benefit which will also be payable by the company at 13.8% (from 2022 at 15.05%). There is no benefit in kind if loan amount does not exceed of £10,000.
In both cases, interest payment to or interest receipt from an individual, the company must account for income tax on a quarterly basis using a CT61 quarterly return based on amounts of tax suffered and deducted at source in the quarter. The CT61 return and any tax is due 14 days following the end of the return period, which are 31 March, 30 June, 30 September and 31 December.
CTA 2010, S.455 is a tax charge on the company, to prevent a director who is a participator (or any other participator in a close company) of close companies from using those companies as an extension to their own private banking facilities without paying any tax. When directors/participators borrow from the company, then they should consider a few things very carefully; company's affordability to lend money, company's cashflows situation and tax consequences for the company and director.
When the DLA is overdrawn and not paid within nine month and one day of the company's year-end then the company needs to pay penalty tax at 32.5% on outstanding balance at that time in accordance with S.455 tax. This rate will even increase to 33.75% in 2022. The S.455 tax should be paid along with the company's corporation tax, which is nine-months and one day after the company's financial year end.
S.455 tax will be re-paid by HMRC when the director repays the loan or the company has written-off the loan. In such cases, the paid tax can be claimed back by the company, which will be paid out after nine months and one day after the company's accounting period when the repayment or write-off of the loan took place. This is a lengthy and long process; therefore, the director's loan accounts (DLA) should always be in credit or at least at zero.
There is an anti-avoidance rule exist when a director is paying-off the loan just before the nine-month one day to avoid the s.455 penalty tax and take another loan within 30 days of repaying the loan. This is known as 'bed and breakfasting'. The repayment of S.455 tax will be restricted when loans totalling £5,000 or more are repaid and borrowed again within 30 days of the repayment. In effect, any repayments within 30-days period are treated as a repayment of the subsequent loan, not the original loan.
Furthermore, if the amount of the outstanding loan before repayment is at least £15,000 and there is an arrangement or an intention at the time of the repayment to draw further loan from the company, regardless of when those further loan are drawn. The repayment of S.455 tax will also be restricted, even when the further amounts are borrowed later than 30 days after the repayment.
The 30-day rule does not apply to a repayment of loan which is made out of income i.e. paid out a bonus or a dividend by the close company which will be subject to income tax.
Write off the loan3
If a company writes-off or releases a loan to a participator or director, the company will receive a repayment of the S.455 tax. The director/participator will be treated as receiving a dividend equal to the amount of the loan written-off or release. An individual will pay any tax via self-assessment, depending on their taxable income and marginal rate. Current dividend tax rate is 7.5%, 32.5% and 38.1% (from 2022 the rate will increase to 8.75%, 33.75% and 39.35%). Writing-off the loan is not an allowable deduction for corporation tax purposes. Where the participator or associate is an employee or director, the loan release or write-off is treated as earnings from employment for National Insurance Contribution (NIC) purposes and becomes subject to Class1 NIC, this means that the employee pays 12% or 2% (in 2022 this becomes 13.25% or 3.25%) of the amount released or written-off, depending on the level of income. The company pays Class 1 NIC at 13.8% (in 2022 this becomes 15.05%). The NIC paid by the company is a deductible expense for the company.
Loans that are excluded from S.455 charge3
Loans made in the ordinary course of business of the company are excluded from the s.455 tax charge.
There is also an exclusion for debts incurred in the supply of goods or services in the ordinary course of the trade unless the credit period exceeds 6 months or is longer than normal given to customers.
There is an exclusion for loans of no more than £15,000 made to a full-time director or employee, who does not have a material interest in the company.
A material interest is more than 5% of the ordinary share capital, or entitlement to more than 5% of the company's assets on a winding-up. When calculating this 5%, we must also take account of holdings owned by his associates.
CONSEQUENCES FOR THE COMPANY
The main consequences for the company which is below;
- If the loan is over £10,000 than the company is required to submit a P11D by 6 July, if later HMRC will charge late filling penalty. Interest needs to be calculated on the average or stick method;
- The company needs to pay NIC1A at 13.8% (in 2022 at 15.05%) on this loan benefit, which is reported to P11D and also, when the loan is written off.
- The company needs to pay S.455 tax at 32.5% (in 2022 at 33.75%) with corporation tax, which is 9-months and 1 day after company's financial year end;
- Director loan's requires reporting to corporation tax return's supplementary page CT600A, even if it is paid before 9-month 1 day but relief for S.455 tax can be claimed on this form;
- The company is required to account for income tax and submit CT61 on a quarterly basis when interest is paid to and/ or received from an individual director.
CONSEQUENCES FOR THE DIRECTOR / PARTICIPATOR4
The main consequences for the director or participator which is below;
- If the DLA is in excess of £10,000 then it is treated as an employment-related loan, so the director/participator needs to be included in the benefit equal to P11D, in their personal self-assessment tax return;
- If the loan is released or written-off, then it is treated as dividend received by the participator, so dividend tax needs to be paid via self-assessments;
- Also, the loan release or writing-off is treated as earnings from employment for NIC purposes and is subject to Class1 NIC. So, the director/employee will pay 12% or 2% (in 2022 this becomes13.25% or 3.25%) of the amount released or written off depending on the level of their employment income.
This is a short summary to consider how to mitigate the overdrawn DLA:
- by paying bonus - the bonus becomes deductible for the company which need to pay employer NIC. The director pays income tax and NIC;
- by declaring dividend - the dividend is paid to all the shareholders and required dividend tax is paid on the self-assessments;
- by repaying the director's loan within nine months and one day after the company's financial year end. However, care is needed in relation to 'bed and breakfasting' anti-avoidance rule;
- by writing-off the loan - the write-off is treated as dividend received by the participator and subject to income tax, but it's not deductible for the company. However, the write-off is treated as earnings from employment for NIC purposes. It will be subject to Class1NIC (employer and employee);
- Taking out director's loans only when there are no other options available and necessary;
- Trying to borrow less than £10,000, so no benefit in kind will arise;
- Ascertaining that the DLA is not overdrawn for a long period of time;
- Being careful with illegal dividend, by ascertaining that the company made profit or has enough retained profits before declaring dividends;
- Do nothing!! The DLA simply be left outstanding and pay S.455 tax at 32.5% (in 2022 at 33.75%) and Class 1A NIC at 13.8% (in 2022 at 15.05%). (It should not be an option).
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.