PROFIT EXTRACTION - 22.05.2008

Didn’t leave enough in the company

Director’s loan account

Scenario. Let’s say you carry on a trade via a limited company. When checking your March 31 2008 accounts in order to prepare the 2007/8 tax return, your advisor finds that your director’s account was overdrawn by just under £1,000. Although you’re not talking about a large amount of money, what is the best way of dealing with this type of situation?

Do nothing. If the loan account is not returned to credit within nine months of your company’s period end, s.419 Taxes Act 1988, it imposes an additional Corporation Tax (CT) charge of 25% on the amount which remains overdrawn. The tax is not refunded until the due date for the payment of CT, in respect of the period in which the loan is cleared. This amounts to a significant period of time to be deprived of funds. The tax charge and the loss of funds continue all the while the matter is not addressed. So the price of inaction can become relatively expensive.

Really a problem

Clearly, the loan will need to be repaid or the tax consequences suffered. These will only cease when the loan is repaid - in turn bringing its own tax charges as shown above. These are inevitable, and it is better to suffer them sooner rather than continuing to bear the consequences of the overdrawn loan.

Rainy day fund. Even if your company is a secondary source of income for you and, in the past, you have left earnings in the company taking no salary or dividends, be aware of the overdrawn loan account trap when you next decide to take a dividend.

Dividend solution

At present, the overdrawn loan account is only £1,000 and so there is no benefit-in-kind to consider (seeThe next step). Consequently, you are only comparing the tax impact of a dividend or paying tax under s.419. If the shareholder (you) is a higher rate taxpayer, the effective rate of tax is 25%. A dividend of £1,000 is grossed up at 90% to £1,111. Taxed at 32.5% this is £361. After the tax credit of £111, the additional tax payable under self-assessment is £250 (subject to rounding for pence), i.e. 25% of £1,000. Tax under s.419 is 25% of the loan, i.e. £250.

Therefore, if you are comparing tax on a dividend with tax on a loan, there is no difference apart from timing. The loan will need to be repaid at some point and so, in normal circumstances, the question is whether to pay a dividend to be taxed through self-assessment, payable on January 31 after the year-end, or s.419 tax on January 1 after the year-end (for a March 31 year-end). The s.419 tax will be refunded after the loan account has been repaid but even then only when the company’s next accounting period has been agreed.

Tip. Draw an extra dividend and then use this to clear your loan account. If your loan account is not returned to credit within nine months of your company’s period end, the Taxman imposes a 25% tax charge. In terms of cashflow, payment of personal tax on an additional dividend is better than repaying 100% of the loan account from private funds. Profits permitting of course.

The next step

For a previous article on the benefit-in-kind situation, visit http://tax.indicator.co.uk (TX 08.16.03).