Tax Update - Directors' loan accounts and P11Ds
Lorraine Owens explains the rules and processes surrounding directors’ loan accounts.
Directors’ loan accounts and P11Ds
If an overdrawn director’s loan account (DLA) balance exceeds £5,000 at any point in the tax year it will be treated as an employment-related loan and a Benefit in Kind (BiK) charge will arise. This is assuming that the loan is not a qualifying loan, unless the director pays interest to the company at least equal to the official rate of interest (ORI) which, for the 2010/11 tax year, is four per cent.
It won’t be long until P11Ds for employees and directors will have to be prepared. A little attention before the end of the tax year may reap dividends.
Type of account
A DLA can be any kind of account or bookkeeping entry in the company’s accounts or just money taken out of the business which is not a legal dividend, salary, bonus payment or expense reimbursement wholly and exclusively incurred for the purposes of the business.
If a director lends money to the company, the DLA will be in credit and there are no tax implications, unless the company pays interest to the director on the credit balance.
If a director has two loan accounts, ensure that the loans are dealt with separately; it is not possible to aggregate them. For example, a credit balance on one account will not offset a debit balance on another.
It is important to keep detailed records of drawings and other transactions which must be reflected in the loan account, such as any personal expenditure or bills paid by the company on behalf of the director or their family, where such expenditure is not a part of the director’s remuneration package. Where the expenditure is part of the remuneration package it will be an allowable expense of the company, and these do not need to be included in the loan transactions; it will be important that the relevant employment taxes are accounted for.
If the transactions are not recorded immediately it may be difficult at the year end to unravel the position of the loan account. It is not good enough to consider an opening and closing balance.
For a dividend to be legal the directors must have made a reasonable assessment of the financial position of the company prior to declaring one; the directors should keep evidence to support this.
There are two kinds of dividends payable to directors (shareholders), either interim dividends or final dividends. Interim dividends can be paid periodically throughout the year where the articles of association permit.
A final dividend is approved by shareholders at the annual general meeting (AGM). If the company has an elective resolution in place to do away with AGMs, only interim dividends can be paid.
Timing of payments
It is important that the right dates are used for dividend credits to a DLA. An interim dividend is not due and payable until it is paid; the date of a resolution is not relevant. Therefore, the date will be the date the cheque or bank credit is processed. In practice though, many dividends are simply credited to the DLA through an accounting entry and here the accounting entry is relevant. A delay in entering the transaction could mean that the DLA remains overdrawn.
A final dividend is deemed to be paid at the date the resolution declaring is passed, or at a later date if that is stated in the resolution. A director may, of course, make repayments to their DLA at any time out of their personal funds.
Loans written off or released
If the company writes off the loan, the amount written off is treated as net income of the director on which tax will be payable at the director’s marginal rate.
A loan written off or released is treated as earnings for National Insurance contribution (NIC) purposes unless it can be evidenced that the writing-off or release was not employment related.
Calculating the benefit
The value of the BiK can be worked out in two ways. The average method can be seen in the following example: loan outstanding at 6 April 2010 is £10,500. Loan outstanding at 5 April 2011 is £6,000. To work out the average add the two balances together and then divide them by two. This gives the figure of £8,250. BiK value is the average balance multiplied by the ORI. So, £8,250 multiplied by four per cent gives a BiK value of £330.
The precise method is more complex but gives a more accurate result. It is up to HM Revenue & Customs or the employee to use this method, not the employer.
The resulting value of the interest is what is reported on the director’s P11D as the BiK, and is the amount on which the company will be liable for Class 1A NIC.
Lorraine Owens is Employment Tax Manager at haysmacintyre.