Definition and Legal Requirement
The Companies Act 2006 permits loans from a company to a director supported by the passing of a resolution of shareholders. A loan to a director is defined as withdrawals from a company that are not salary, dividends or repayment of expenses or repayments of money previously loaned to the company.
It is essential to properly record such monies as there are tax consequences for both the company and the director. Any loan outstanding at the year end and not repaid within 9 months of the year end will be subject to tax on the company at the current rate of 32.5%. This tax is repayable when the DLA is repaid.
Once a company enters into Administration or Liquidation the appointed Administrator or Liquidator is required by law to investigate where there are any overdrawn DLA’s. This is done by analysing the company’s financial statements and books and records.
When an Administrator or Liquidator establishes the existence of an overdrawn DLA there are a number of ramifications, the most important being:
- Details of the overdrawn DLA will form part of the Director’s conduct report that the Administrator or Liquidator is required to submit to the Insolvency Service. This will impact upon the Insolvency Services decision to commence disqualification proceedings;
- The overdrawn DLA will be treated as an asset of the company and the Director who received the benefit of the Loan will be held liable to repay it; and
- If the overdrawn DLA is not repaid, HM Revenue & Customs may seek payment of the taxable amount of the Loan and (if the Loan is interest free) to treat the interest saved as a benefit in kind to be recorded on the Director’s Self Assessment Return.
The best way to counter any challenge that a DLA was or is overdrawn is to ensure that at each year end the balance is cleared either by an injection of funds, the declaration of a dividend (reserves permitting), a director’s bonus or a mixture of the foregoing.
However, the above remedies may not be possible, or subject to challenge if the company is insolvent or in financial difficulty.
Can the Company reclaim Corporation Tax on Director Loans?
Yes. Once the loan has been repaid in full or part, the company can reclaim on the corporation tax on that part repaid. The tax is repayable within 9 months from the accounting year ended in which the loan was repaid, and needs to be claimed within 4 years.
Can Directors withdraw another Director’s Loan once the initial loan has been paid in full?
Yes. Once the initial loan has been paid in full, Directors are entitled to take out another director loan, with the approval of shareholders. However, there is a thirty-day cooling-off period during which no sum greater than a small amount can be borrowed. This is to restrict Director’s working around the rules by repaying the loan prior to year-end, only to borrow again soon after. This is known as ‘Bed and Breakfasting’. If there is a further borrowing soon after the Director has repaid the initial loan, it is considered to be a continuous borrowing to the initial loan withdrawal and charges to tax will be payable.
How much can a Director withdraw as a Director Loan?
There is no legal limit to how much a director can withdraw from the company in a form of a loan. However, it is critical to withdraw an amount that is not at the detriment of cashflow. If a director withdraws more than £10,000.00, this will be treated as a ‘Benefit in kind (P11D)’ and must be reported on the director’s self-assessment tax returns to HMRC. Tax would be applied on the loan. It is important to seek the approval of all the shareholders.
What is an Associated Loan?
Associated loans are loans that Directors provide to associates such as connected entities, key management personnel or family and friends. Directors should be wary of making loans to other companies that they are connected with or loans to connected persons if there is no commercial benefit in doing so. An example may be a director advancing money to a newly formed business set up by a spouse or other family member which brings no benefit to the lending company and may affect its own cashflow position.
What Are the Ramifications of Making an Associated Loan?
The Directors of the lending company could face criticism and personal financial loss if their company becomes insolvent and the loan cannot be repaid. The appointed Liquidator or Administrator could bring proceedings against the Director for Misfeasance as the loans made were not in the company’s best interest. This would form part of the Director’s conduct report that the Administrator or Liquidator is required to submit to the Insolvency Service. A subsequent director’s disqualification could result depending on the size of the loan and the effect it had on the lender.
What is the Defence to an Associated Loan?
The best defence is not to make the loan, but it is not uncommon for Directors of cash rich companies to offer assistance in helping family members or close friends set up new businesses. However, they need to be aware of the pitfalls if the debt becomes bad and their own company suffers as a consequence. A means of protection would be to ensure that proper loan documentation is drawn up with a commercial rate of interest and an agreed repayment period. If possible, the loan should be secured by personal guarantees, supported by tangible assets and/or by taking a debenture in the new business. A further defence might be to treat the advance as an investment in the new business so that it can be claimed that there was some commercial benefit to the monies advanced. Depending on the size of the advance a board resolution should be approved in which details of the loan and the financial strength of the company should be considered, together with any details as to whether the company can claim any commercial benefit for the loan.
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