Any payment made to a director as part of their remuneration package is generally subject to tax that is usually collected via the PAYE system. The payments made by the employer are allowable expenditure and reduce the employer’s taxable profits.
However, many smaller limited companies pay personal expenses on behalf of directors. These personal expenses do not form part of the director’s remuneration package and should not be included as an expense in the company’s accounts – a company may not deduct expenditure unless it is incurred wholly and exclusively for the purposes of its trade.
Which begs the question, how are these personal expenses of the director treated in the company’s accounts? Unless reimbursed by the director, such personal expenses are debited to the director’s loan account.
Of course the director may have introduced funds into the company at some time in the past in which case the debiting of personal expenses will simply reduce the amount owing to the director. Problems only arise when the director’s loan is overdrawn, in which case the director owes money to the company. Two tax complications arise:
1. Company liable to additional Corporation Tax charge.
If the director is also a shareholder in a “close” company, any overdrawn balance on a director’s loan account at the end of the company’s accounting year will create a potential Corporation Tax charge based on 25% of the amount overdrawn at the year end. For example, if John, a director and shareholder of A Ltd, has an overdrawn loan account with the company at their year end, 31 March 2012, amounting to £10,000 then a potential liability to Corporation Tax will arise of £2,500. This liability will be reduced or cancelled if the loan is reduced or repaid in full before 31 December 2012 (9 months after the accounting year end). Even if the loan is repaid after the nine month deadline, the company can apply to have the additional tax repaid although there may be a significant delay. Quite often the overdrawn balances are cleared by paying dividends which are credited to the loan account within the nine month period.
2. Director may face a personal tax charge.
If A Ltd in the example quoted above, had made no interest charge to John for the loan of the £10,000 then HMRC would seek to tax John as if he’d received a benefit (the interest forgone). If John had owed more than £5,000 at any time during the year to 5 April 2012 he would be assessed to a benefit in kind charge. HMRC currently use a 4% rate to calculate the benefit which means John would pay tax on a benefit in kind charge of £400. Additionally, A Ltd would be liable to a Class 1A National Insurance charge on the same amount, i.e. on £400 assuming £10,000 was owed for a full year.
To avoid the personal tax and Class 1A charge, A Ltd could charge John for the statutory interest by crediting interest received in its accounts and debiting John’s loan account with the same amount of £400. John would then need to repay £10,400 before 31 December 2012 in order to ensure HMRC would withdraw the additional Corporation Tax charge.
Accounting for directors loan transactions can be complicated especially if the company makes an interest charge to the director.