Background
When a director’s loan account (DLA) becomes overdrawn, it can trigger several tax consequences. These include potential charges under the ‘loans to participators’ provisions (CTA 2010, s 455), benefit-in-kind charges under the beneficial loan rules (ITEPA 2003, s 175), and income tax charges if the loan account is released or written off (CTA 2010, s 415). The company may also have to repay any corresponding tax charge on the loan (CTA 2010, s 458).
It’s All in the Timing
The timing of DLA credits, repayments, or any release or writing-off of the loan account is crucial for tax reasons. It affects the date of payment or repayment of any loans to participator charge, the tax year in which a beneficial loan income tax charge for the director is reduced or ceases, and the tax year in which the repayment, release, or writing-off of the loan account is taxable on the participator.
Earnings
Tax rules determine when cash earnings are considered received for employment income purposes (ITEPA 2003, s 18(1)), and similar rules apply for PAYE purposes (ITEPA 2003, s 686(1)). Crediting an account in the employer’s books represents ‘payment’ for these tax purposes (see HMRC’s Employment Income Manual at EIM42270).
In many owner-managed and family companies, directors often draw money from the company during the year, debited to their loan account and repaid at the end of the year by crediting earnings voted or declared post-year end. Until then, these drawings do not belong to the director and aren’t payments on account of earnings for tax purposes (see EIM42280).
Dividends
An overdrawn loan account of a director shareholder is often cleared or reduced by crediting a dividend from the company to the loan account. However, care is needed to ensure company law requirements are satisfied, such as proper voting, payment, and formal documentation by minutes, dividend vouchers, etc. It’s also important to know when a dividend is considered paid.
Company articles often distinguish between final and interim dividends, with final dividends declared by the company in general meeting and interim dividends paid by directors from time to time.
A properly declared final dividend without a specified payment date creates an immediately enforceable debt, while an interim dividend can be varied or rescinded before payment and is only due and payable when actually paid (Potel v CIR (1971) 46 TC 958).
HMRC considers an interim dividend paid when a right to draw on it exists, generally when appropriate entries are made in the company’s books. If these entries aren’t made until the annual accounts are prepared after the accounting period in which the interim dividend was resolved, the due and payable date will be in the later accounting period, possibly delaying repayment of an overdrawn director’s loan account.
General Repayments
HMRC may accept DLA repayments via book entries if they reflect the transaction’s underlying reality and are properly recorded in the company’s books. However, a repayment by book entry is normally treated as occurring when the entry is made, and relief on loans to participators (CTA 2010, s 458) is due only on that date (see CTM61600).
Which Debt?
Many director shareholders have a single DLA with the company. HMRC’s guidance on loans to participators (CTM61600) states that where there are multiple loans or advances on a single loan account, repayments can be set against any debt specified by the participator or the company. If not specified, HMRC will set repayments against the earliest debt first, following Clayton’s Case [1816] 1 Mer 572.
DLA Written Off: Or Was It?
In Plumpton v Revenue and Customs [2024] UKFTT 367 (TC), a director’s loan account showing £783,289 as written-off in 2013/14 was disputed. The First-tier Tribunal concluded the loan wasn’t written off due to lack of relevant documents from that tax year. The taxpayer’s appeal was allowed, showing the importance of proper documentation.
Record Keeping
HMRC’s Directors’ Loan Account Toolkit highlights risks if transactions relevant to DLAs aren’t posted contemporaneously. Keeping the DLA up-to-date can save further work in the long run.
Contributed by Mark McLaughlin