The importance of record keeping for a director’s loan account
Anti-avoidance rules introduced in recent years give HMRC extra powers to charge tax where a director borrows money from their company. This makes it more important than ever to keep track of transactions. What’s the best way to do this?
Ins and outs
The most common type of directors’ loan happens to be the one that causes the most trouble with HMRC. We’re talking about your director’s loan account (DLA). As a director it’s almost certain that at one time or another the company will owe you money or you’ll owe it, for example where you draw money from the company’s bank account for personal use. Where you owe money, HMRC refers to this as having an overdrawn DLA, and he has a distinct dislike of these.
Basic tax charge
Where your DLA is overdrawn at the end of your company’s financial year, it has to pay tax equal to 25% of the amount outstanding. The good news is that this will be repaid by HMRC nine months after the end of the financial year in which you repay the money you owe. However, there’s a way to escape the tax charge altogether.
Tip. Where you settle the balance on your loan account within nine months of the end of your company’s financial year, HMRC will forego the 25% tax. For most owner-managed companies the usual way of doing this is by paying a dividend or bonus to cover the amount owing on the DLA account as it stood at the end of the financial year. This sounds simple but in practice it usually isn’t.
DLAs are rarely overdrawn as a result of a single transaction. You’ll probably know from experience that there’s often a multitude of ins and outs that make up the balance. It’s often your accountant, when preparing the company’s annual accounts, who works out the precise amount overdrawn. The usual approach is to follow the tip above and use a dividend or bonus to credit the loan account.
Trap. The trouble is that credit for this type of bonus or dividend will be made several months after the financial year end. By then your loan account might well be overdrawn again as a result of later transactions. And if HMRC takes a look at your records, it has been known to argue that the account balance was never settled as it’s never actually reduced to nil.
The right order
There’s more than one court ruling which says that where you owe money and make a repayment, you can nominate which part of the debt this is set against. This means you’re entirely within your rights to set the full credit from a year-end dividend or bonus against the earliest transactions on your DLA. We’ve seen cases where HMRC argues against this but even its own internal instructions are against it. So if it tries it on with you, point it to the internal instruction manual at CTM61605.
Tip. Use a spreadsheet to keep track of the balance on your DLA to allow you to easily allocate repayments in the most tax-efficient way.
Book a free call
Leave your details and we will email you to arrange a call back to discuss your accountancy needs.