DIRECTORS’ TAX - 16.03.2015

Time to plan your year-end bonus?

Extra tax

As the owner and director of your company it’s usual to dip into your company’s bank account from time to time. HMRC is less keen on the idea. If you owe your company money at its financial year end and you don’t repay it within the following nine months, it will have to pay extra tax on top of its normal corporation tax bill. The extra tax is equal to 25% of whatever you still owe.

Clearing your debt

At one time you could work around the time limit by borrowing more money from your company and using it to repay the original debt before the nine months was up. In effect you recycled the loan. This loan recycling meant the extra tax was avoided, but anti-avoidance rules were introduced to stop this practice. However, the rules allow you to repay your original debt and borrow again without triggering the extra tax as long as it’s done in a certain way.

Paying a bonus

Where your company awards you extra salary, a bonus or dividends, which you don’t draw but instead use to repay what you owe your company within the nine months, the slate is wiped clean and you’re free to borrow again without the risk of the extra tax - at least until nine months from your company’s next financial year end.

Example. Acom Ltd has two directors Bill and Ben. At the end of its financial year, 31 March 2015, they owe Acom £11,000 and £12,000 respectively. Acom’s draft accounts show £100,000 profit. Before these are finalised in August 2015 Bill and Ben approve a bonus sufficient to clear what they owe Acom. However, when the final accounts are produced the bonuses aren’t shown. Their accountant explains that while they relate to the profit for the year ended 31 March 2015, the decision to pay the bonuses was made after that date. Accountancy and tax rules say that expenses can only be deducted in the accounting period in which the obligation to pay them arose. Trap.  This is bad news for Acom because it means it won’t receive a tax deduction for the bonuses until its following financial year. In tax terms the effect of the delayed tax relief is broadly equal to the extra tax it would have had to pay if Bill and Ben hadn’t used their bonuses to repay the company (see The next step ).

Early approval

The solution is for Bill and Ben to approve their bonuses before Acom’s year end. However, that might be tricky because the amount they owe isn’t known until the accounts are in draft, by which time it’s too late and they are caught by the trap explained above. Tip.  Acom can draw up an agreement before 31 March 2015 to pay Bill and Ben a bonus sufficient to cover whatever they owe (see The next step ). That creates an obligation to pay their bonuses at the year-end date, which means it can claim the expense in the accounts to which the bonuses relate and not the following year. This will avoid the trap and make the arrangement tax efficient.

For the tax effect of the delayed deduction and for a sample bonus agreement, visit http://tipsandadvice-tax.co.uk/download (TX 15.12.06).