Technical Briefings
21 July 2010
Directors Loan Accounts - friend or foe? July 2010
Director’s loan accounts (“DLA’s”) are a mechanism by which a director of a limited company benefits from the use of company funds for his personal expenditure. They are often found to have been used as an alternative to drawing a salary but can also have been used to loan the director a lump sum of money.
The director, or a person connected with the director, receiving the benefit of the money is not required to pay income tax on the amounts borrowed but is required to pay income tax on the deemed interest, if the loan is interest free.
The company, however, is required to declare the loan balance and any movement on the DLA on its corporation tax returns. The company incurs a tax liability equal to 25% of the loan under Section 419 ICTA 1988 if the loan has not been repaid by the director within the nine months following the tax year in which it was borrowed. This is held by HM Revenue and Customs pending the director repaying the loan monies, and becomes repayable in the subsequent accounts years, once the company’s accounts and tax returns have been filed.
The monies advanced by the company to the director through the DLA are considered to be a loan and therefore repayable at some point in time. This may seem like an obvious statement but you’d be surprised how many directors are not aware of this fact!
A second issue arises where the director is also a shareholder of the company. It is often seen to be the case that dividends are declared to repay the DLA, in full or in part, but it is important to note that a dividend cannot be declared unless there are profits available for the purpose. This is now covered under Section 830 of the CA 2006.
If there are no profits available for distribution and the company will be continuing to trade for the foreseeable future then it is likely that the DLA will remain outstanding until the financial year in which there are sufficient distributable reserves to pay a dividend to the shareholders and so clear the DLA.
But what happens if the company’s financial position deteriorates for one reason or another and the directors of the company are required to enlist the help of an insolvency practitioner?
It is the statutory duty of any Administrator, Liquidator or Administrative Receiver to review the company’s records, once appointed, in order to make a report to the Insolvency Service on the director’s conduct in the three years prior to insolvency. During this review, if it hasn’t been highlighted before, the presence of a DLA will be noted and if there is no evidence of the balance having been repaid by the director, the loan account now becomes an asset in the insolvent estate capable of being recovered for the benefit of the company’s creditors.
During the insolvency practitioners investigations they will also review the dividends declared by the company in the previous three years to ensure that there were sufficient profits available to warrant the declaration of the dividend. If a dividend was declared “illegally” then the insolvency practitioner will revert to the shareholders for repayment of the same under Section 277 of the CA 2006.
So, the moral of the story is? Whether you are a director who has a loan account within a company or an accountant advising your client, it is important to remember that a DLA is essentially no different to a loan from the bank – it will need to be repaid at some point in time. Even a business previously thought to be indestructible can find itself in an insolvent position so if the profits aren’t there to declare a dividend, don’t draw them and don’t operate a DLA unless you know that you are going to be able to pay it back!
