Financial Update Spring 2019 Newsletter

3 Winter 2018 irectors of owner-managed companies may overdraw their loan account by withdrawing company funds to cover personal living expenses. There are sometimes good reasons for simply waiving or releasing the debt, even though that is not necessarily the most tax-efficient approach to the issue. WHYWRITE OFF? Where a director who is also a shareholder has an outstanding loan or current account with a close company, the company will have to pay 32.5% in tax if the loan is outstanding for more than nine months after the end of the company’s accounting period in which the loan was made. So, it is generally a good idea to get rid of the debt before the nine months are up. Clearing the overdrawn account by voting a bonus or dividend is generally more tax- efficient than writing it off, but there can be difficulties with both types of payment: ■ ■ Voting a bonus may be possible but HMRC may argue that the director has received payments on account of their employment income. PAYE and national insurance contributions (NICs) will then be applied to the funds that have been withdrawn – and there could also be penalties. ■ ■ Voting a dividend may not be practical if other shareholders don't wish to receive dividends. A bonus payment will probably be subject to higher rates of income tax and NICs but it will benefit from corporation tax relief. A normal dividend payment will avoid NICs and be charged tax at the marginal rate of 0%, 7.5%, 32.5% or 38.1%, depending on income. TAX TREATMENT OF AWRITE OFF Where the loan has been written-off, the director is treated as receiving a dividend equal to the amount written-off. This means dividend tax is paid at the marginal rate. However, the written-off loan account is also treated as earnings for NICs, so the director will pay 12% and/or 2%, with another 13.8% payable by the company. Further, despite the earnings treatment, the company does not receive corporation tax relief for the write-off. WHAT NOT TO DO The First-Tier Tribunal decision involved four companies that used a loan waiver scheme promoted by the same adviser. It was heard collectively as Esprit Logistics Management Ltd and Others v HMRC. In the case: ■ ■ The companies voted to issue the directors with performance bonuses equivalent to the amount of overdrawn loan accounts. ■ ■ The bonuses were paid as a formal release of the overdrawn loan accounts. The tribunal decided that the directors’ loans had been repaid, rather than released, because the companies effectively got their money back. So, the write-offs were treated as employment income rather than dividend income and the higher rates of income tax applied. The companies made the mistake of setting up close links between the bonuses and the write- offs, instead of just waiving the loans. It also didn’t help that the directors increased their loan accounts after being voted the bonuses, so they matched the agreed bonus amounts. The case highlights the current attitude of the Tribunals and Courts towards perceived tax avoidance. Please contact us if you would like advice on how to handle your director loans. D There are sometimes good reasons for simply waiving or releasing the debt, even though that is not necessarily the most tax-efficient approach to the issue. Closing loopholes around director loans A recent First-Tier Tribunal decision has drawn attention to the tax treatment of writing off director loans. TAX iStock/Andrii Yalanskyi SAMPLE