LOANS - 04.04.2014

New directors’ loans repayment trap

New rules starting to hit

Wide reaching anti-avoidance rules relating to companies that lend money to their director shareholders were introduced in 2013 but they’re only just starting to hit hard. This is because many companies are only now drawing up accounts for periods to which the rules apply. Many directors are finding that the rules are trickier to apply in practice than they appear in theory.

Directors’ loan accounts

You’ll often see examples of the new anti-avoidance rules given in simple terms, where a director borrows a fixed sum and repays all or part of it before borrowing a further chunk of cash. However, as you might know from experience, it’s rarely that clear cut. In small companies the balance of what their directors owe often change frequently in dribs and drabs. So where do you start looking to see if the anti-avoidance rules apply?

Start at the end

It might be traditional to start at the beginning, but the opposite is true for directors’ loans. You start by adding together everything owed by the director to their company at its financial year end. Having settled on the amount you can check if the anti-avoidance conditions apply.

Tip. Where the director’s debt at the company’s year end is less than £5,000, the anti-avoidance rules won’t apply, but with one exception.

Trap. The exception applies if, within 30 days of the financial year end the director reduces their debt by more than £5,000, and then within 30 days borrows again from the company.

Example part 1. Sue is a director of Acom Ltd. Its financial year ends on 31 December. As at 3 December 2014 she owed Acom £4,000, by the 8th £5,000 and by the 10th, £7,000. On 15 December she repaid £4,000 and on the 31st, £3,000 so that she owed nothing at Acom’s financial year end. Because there is a zero balance on her director’s loan account it would seem that no tax charge would arise. However, what happened next will change that.

Example part 2. On 2 January Sue borrowed £6,000 from Acom. Because this was within 30 days of the repayments the anti-avoidance rules match them against each other. This means the £4,000 repayment and £2,000 of the second, count as reducing the £6,000 she borrowed on 2 January. Therefore, for tax purposes, she owes Acom £6,000 at 31 December 2014 on which it will have to pay a 25% tax charge (see The next step ). However, the good news is that it can be avoided

Further repayments

Our example shows how easy it is to fall foul of the anti-avoidance rules. However, it’s almost as easy to correct the situation.

Tip. If Sue makes a further loan repayment within nine months of Acom’s year end, i.e. by 30 September 2014, it will reduce the £6,000 on which the 25% tax charge arises. The most tax-efficient way of doing this is for Acom to credit Sue’s loan account with a dividend or salary to cover the £6,000 she’s deemed to owe at 31 December.

For more information on the 25% tax charge, visit http://tipsandadvice-tax.co.uk/download (TX 14.13.05).