Director’s loans are one of the most common methods by which director’s draw funds from their company, either because they intend to declare a dividend at the year-end or to avoid the financial obligations they may be imposing on their company’s business.
It is only during the year, or when the year closes, that difficulties arise in accounting for such loans in order to avoid the taxes arising and the obligation to repay such sums.
Directors loans as loans
Where a director draws money from a company without accounting for it as income in the company’s books and records, it may be accounted for as a director’s loan.
- if a director’s loan, whether accounted for as a director’s loan or not, is unpaid at the year-end then there is a charge to tax comprising 25% of the amount outstanding as at the year-end.
- this charge is repayable to the company if the director repays the loan in its entirety.
However, if the loan is not repaid and instead written off, the tax will usually not be refundable. We recommend in such circumstances you seek advice from your accountant.
More seriously though, if a director’s loan is not repaid it will still remain a liability of the director and this can be a serious problem when the loan remains outstanding and the company is placed into insolvency.
Directors loans set off against dividends
Frequently a director may receive advice to take loans from the company and, at the year-end, declare a dividend which results in a paper transaction whereby the dividend declared is credited against the director’s loan account (provided the director is also a shareholder).
This, potentially combined with an income sufficient to absorb the director’s tax allowance, is a very common method of mitigating the director’s tax liabilities.
- however, this relies on the company being profitable and having sufficient reserves to enable such dividends to be declared when at the year-end, which is not guaranteed;
- if a director finds out at the year-end that s/he cannot take dividends to set-off their loan, they may be liable to repay the loan or, as a minimum, account for the 25% tax liability owed to HMRC as set out above.
Even worse, if a company is placed into insolvency at some point during the year (and before a dividend is declared) then the director’s loans will remain outstanding and be immediately repayable to the company in insolvency, potentially with added interest, even though such sums would not have been payable if taken as salary.
There are various claims that can be made against directors.
At Francis Wilks & Jones we are able to assist with any legal matters arising in respect of the above tax disputes and particularly with regard to claims out of insolvency or claims for breach of misconduct and a director’s fiduciary duties. Alternatively we can assist you in finding a tax accountant suitable to your needs, both in terms of their size and geography.