Beware of Directors' Loan Accounts

Published: 15th June 2012
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Copyright (c) 2012 Alison Withers

Using directors' loan accounts as a device to help minimise their personal tax liabilities is often something accountants advise their clients to do. However they only work when the directors are also shareholders and the company is making profits.

In essence they involve the directors borrowing money from their company and drawing only a minimum salary through their company's payroll. The directors' loan account is paid off by declaring a dividend. The mechanism is a legal way for directors to minimise their personal tax and it avoids having to pay employee and employer National Insurance contributions.

This may be fine when a company is profitable and things are going well, but it can become a problem if the company does not have sufficient profits as distributable reserves that can be used to clear the loan.

Company rescue advisers are coming across increasing numbers of companies that have not made a profit and where the loan cannot be cleared, leaving the directors effectively owing money to the company.

This can be a substantial and serious problem if the company is in difficulties and hoping to reach a Time to Pay (TTP) agreement with HMRC to defer payment of corporation tax, PAYE or VAT.

HM Revenue and Customs normally stipulates that such loans are repaid as a pre-condition of approval.

Similarly, it can cause problems when proposing a Company Voluntary Arrangement (CVA) or when a company becomes insolvent.

If an administrator or liquidator is appointed, they will most likely ask the director(s) to repay the loan borrowed from the company. Before approving a CVA, experienced creditors and in particular HMRC tend to demand repayment of the directors' loans.

It is rare that this downside is considers and it is generally forgotten that such attempts to reduce tax carry the risk of creating a huge personal liability. To avoid it, company rescue advisers recommend that such dividends are declared in advance so as to avoid a loan or at least regularly to avoid building up a huge directors loan account. This avoids the normal practice of waiting until long after year end when the annual accounts are prepared during which time the company may incur losses that mean dividends cannot subsequently be declared.

A further warning relates to any directors' loan account that is outstanding at the company year end and as such will be highlighted to HMRC in the accounts. Regardless of any intention to reduce the tax liability, tax legislation seeks to limit the benefit by imposing a section 455 CTA 2010 tax liability (under Corporation Tax Act 2010, formerly s419 of the Income and Corporation Taxes Act 1988). Although this tax can be recovered when the loan is subsequently repaid by the director, whether in cash or as a dividend, it triggers a significant tax liability on the company.

Countless examples come to mind but one in particular. A printing company had for several years been incurring losses and the directors in an attempt to preserve cash in the business had borrowed from the company to reduce cash flow by avoiding having to pay tax and national insurance. The company was eventually put into liquidation and the directors both had to declare themselves bankrupt because they could not repay their loans. Had they taken advice or paid themselves a salary through the payroll, they could have avoided this, albeit the company may have owed more to HMRC.

In conclusion, director loan accounts are a clever way of legally reducing PAYE tax liabilities, however, it is important to consider the downside that they become a personal liability in the event of insolvency and a company tax liability if not paid by year end.


A directorsí loan account can be a useful device for minimising personal tax liabilities but rescue advisers say it only works when the company is in profit.† By Ali Withers.

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