The directors’ loan account is an important aspect of how a private company operates its business and records transactions with its directors/shareholders, yet it is also a subject in respect of which there is a considerable amount of confusion, not least the tax implications arising in certain circumstances.

Credit balances

Where, in net terms, a director has introduced funds to a company such that the company owes money to that director then generally the consequences are fairly straightforward. Interest may be charged by the director to the company, if desired, at a reasonable rate (perhaps currently up to about 6% p.a.). Any interest payments made must be subject to a 20% tax deduction at source with any higher rate liability collected via the director’s self-assessment tax return. 

Interest paid to directors, while taxable, can be a useful form of profit extraction as no liability to National Insurance arises and the company receives corporation tax relief on such interest paid. The director, of course, needs to appreciate that recoverability of the amount due may be an issue if the company were to fail. In addition, a failure to recover a loan to a (trading) company by a director/shareholder will, for tax purposes, only give rise to a capital loss (and as such will only be available for relief against capital gains rather than the much more valuable relief against income tax available in respect of some other types of loss).

Overdrawn balances

Loans to directors are where in net terms the director/shareholder has withdrawn more funds than they are entitled to results in a debit or overdrawn balance. Strictly speaking, any such arrangement (where the overdrawn balance is £10,000 or more) should be formally approved by the shareholders of the company to comply with the requirements of the Companies Act 2006 and all overdrawn balances (at whatever level and even if repaid in full by the balance sheet date) must be disclosed in the company’s annual accounts. 

Furthermore, if there is an overdrawn balance then the director/shareholder has an obligation to repay the balance at some point, either by introducing funds to the company or from credits which will be due from the company (e.g. dividends) to the director at some point in the future. Difficulties can arise where future credits are anticipated but do not materialise, often as a result of the failure of the company.

Notwithstanding the above, it would be very simple for a director/shareholder in a private company to arrange for profits to be extracted from the company by way of a long term loan with no personal income tax liability, rather than by either a director’s bonus or shareholder’s dividend which are taxable on the individual. To counter this Section 455 Corporation Tax Act 2010 imposes a tax liability on the company.

By David White a Partner in Charterhouse, based in Beaconsfield