For many small Limited Companies it is quite a common strategy (right or wrong) for Directors/ Shareholders to draw funds out of the company and make a dividend declaration at the end of the year. Where this often goes wrong is that the director will withdraw too much thus creating an overdrawn directors loan accounts.
Always remember that even if it is your company, it is still a separate legal entity. Any money going in and out from the Director needs to be accounted for correctly.
The rules surrounding loans to participators of close companies are becoming more stringent. HMRC defines a participator as a person who has a share or interest in a company. A participator is usually a shareholder but could also be a director. A participator includes any ‘associate’ – for example, spouse or civil partner, business partner, relative, trustee, or a loan creditor. A participator’s interest in a company can be in its capital – for example, shares.
HMRC defines a ‘close company’ for Corporation Tax purposes as a company that is controlled directly or indirectly by five or fewer participators – or any number of participators if they are all directors.
Where a close company makes a loan to one of its participators the company must pay 25% of the loaned amount at the balance sheet date as s455 (formerly s419) tax. This only applies if the loan is not repaid within nine months of the end of company’s accounting year.
Historically the 9 month rule has been abused. Effectively the director would repay the loan just before the nine month deadline and immediately take out a replacement loan from the company.
As a result HMRC will be applying new tax avoidance rules from 20 March 2013. The replacement of a repaid loan within a short period of time will not be allowed to count as a repayment of the first loan. If at the time of the repayment there are arrangements or intentions to make further loans, which are later actually made, the repayment condition will also not be met.
At present there is no definition of ‘short time’ however, this blog post will be updated once we hear about it.
It is also worth remember that when you pay off a director’s loan on which your company has paid Corporation Tax, the company can reclaim that amount of Corporation Tax paid.
The best way to manage the situation is with good record keeping, strong business management and effective tax planning.