How to avoid risks in the director’s loan account? HMRC produce a series of toolkits which set out common errors that they find in returns. Here are some steps to avoid to fall off in the pit. Although the toolkits primarily aim at agents, they are useful for anyone who has to complete a tax return.
The director’s loan accounts toolkit highlights the key areas of risk in relation to directors’ loan accounts. The latest version of the toolkit came out in May 2019 and can come in handy for personal tax returns for 2018/19 and for company returns, for the financial year 2018.
Expenses are only deductible in computing taxable profits to the extent that they incur wholly and exclusively for the purposes of the trade. A company is a separate legal entity to the directors and shareholders. However, many close companies meet the director’s personal expenses.
Where these are not part of the director’s remuneration package, the company cannot deduct cost when computing its taxable profits. Instead, the director’s loan account should get the bill. The director’s loan account toolkit focuses on expenses that do not form part of the director’s remuneration package.
Risk areas with the director’s loan account
- Review of the accounts – any personal expenditure incurred by the director and the company pays for it must be correctly allotted, i.e. an allowable expense where it forms part of the director’s remuneration package and invoice to the director’s loan account. Account headings should be reviewed to identify the director’s personal expenditure which has not been treated correctly.
- Loans to participators – under the close company rules, tax (section 455 tax) is charged at 32.5% on loans to directors who are also shareholders where the loan remains outstanding nine months and one day after the end of the accounting period. Review overdrawn loan accounts to check whether the company is liable to pay section 455 tax.
- Assessment of expenses and benefits – where a director is gets anything other than pay, HMRC needs to know as a benefit in kind on form P11D. Analyze expenses and benefits for taxable items that may have been missed. It should be noted that if the director’s loan account balance exceeds £10,000 at any point in the tax year, a benefit in kind charge will arise on the loan unless the director pays interest at a rate that is at least equal to the official rate (2.5% since 6 April 2017).
- Self-assessment – check whether the director needs to send a self-assessment return. The directors’ loan accounts toolkit states that “Company directors do not need to send a tax return unless that have other taxable income that needs to be reported, or if HMRC has sent a notice to file a return”.
- Record keeping – good keeping is essential. Poor records may mean expenditure is missing or handout incorrectly.
The toolkit features a useful checklist that can be complete to make sure that nothing slips up. The checklist contains a helpful link to HMRC guidance.
Additional note: Directors’ loan account toolkit, see www.gov.uk/government/publications/hmrc-directors-loan-accounts-toolkit-2013-to-2014.