Directors’ Loans: Bed And Breakfasting Etc. - You Really Need To Know These Rules!

Ken Moody looks at anti-avoidance rules affecting directors’ loans.

Two years on from the introduction (by FA 2013) of the anti-avoidance provisions aimed at the ‘bed and breakfasting’ (‘B&B’) etc., of directors’ loans, the rules are still poorly understood and misconceptions linger.

Loans to participators

The ‘loan to participators’ provisions (CTA 2010, s 455; all references in this article are to CTA 2010, unless otherwise stated) creates a charge to notional corporation tax at a rate of 25% on the amount of any loan to a shareholder. There are exceptions where the shareholder is also an employee or director and:

the loan is not more than £15,000; and
the director or employee works full-time for the company (or group); and
the director or employee does not have a ‘material interest’ in the company.

A ‘material interest’ is basically more than 5% of the ordinary share capital (see s 457 for the full definition).

No tax is payable under s 455 if the outstanding loan at the end of the accounting period is cleared by the time the corporation tax for that period becomes payable (i.e. nine months and one day after the end of that period). It is quite common for the loan to be cleared by crediting the director’s loan account (‘DLA’) with a dividend (or less usually remuneration for National Insurance contributions reasons) just before the end of the nine months. This practice remains valid.

Loan pitfalls

Anti-avoidance provisions (in CTA 2010, s 464C) deal with B&B etc. arrangements and apply where either:

within a period of 30 days there are repayments totalling more than £5,000 in respect of a loan to which s 455 would apply; and during the same period further withdrawals exceeding £5,000 are made, or
the total amount owed is more than £15,000 and a repayment is made, but at the time of the repayment there are arrangements in place to make further withdrawals totalling over £5,000.

In both cases, the repayments towards the loan are matched with the further or anticipated further withdrawals. Otherwise, unless the parties to a loan agree otherwise, repayments are allocated against a debt on a first-in-first-out basis, based upon what is usually referred to as ‘Clayton’s Case’ (Devaynes v Noble [1816] 35 ER 781).

Two simple examples will serve to illustrate these rules.

Example 1: Loan repayment and further withdrawals

Ben owns 25% of the shares in Zephyr Ltd and borrows £10,000 just before the company’s year end on 31 October 2014. He repays the £10,000 on 20 June 2015 but withdraws £3,000 on 5 July 2015 and a further £4,000 on 15 July 2015.

As repayments exceeded £5,000 and further withdrawals totalling more than £5,000 have been made during a 30 day period, the repayment of £10,000 is first matched with the further withdrawals. The unmatched £3,000 reduces the balance at the year end to £7,000 on which s 455 tax is payable on 1 August 2015 of £750 (unless further repayments are made which are not within the s 464C rules).

Example 2: Arrangement for further withdrawal

Julie owns 100% of the equity in Zodiac Ltd and withdraws £50,000 from her DLA on 30 September 2014. The company’s year-end is 31 October. She arranges a temporary bank overdraft and repays the £50,000 on 1 July 2015, but on 1 October 2015 she will withdraw the same amount to repay the overdraft.

She is caught by 2) above, since although the repayment and further withdrawal are outside the 30 day period in a), at the time of the repayment Julie knew that she would need to withdraw a similar amount to repay the overdraft and therefore arrangements are in place to make a further withdrawal to replace the amount repaid.

The repayment is therefore matched with the later withdrawal, leaving the whole of the balance at the year-end of £50,000 still outstanding, on which s 455 tax is payable of £12,500 on 1 August 2015 (again, unless further repayments which are not caught under s 464C are made by then).

Common misconceptions

The following comments are based on some misconceptions which I have come across in practice:

‘In Example 1, the 30 day rule does not apply since neither of the further withdrawals are more than £5,000’. It’s the total withdrawals within the 30 day period which counts.
‘In Example 2, since the repayment and further withdrawal are outside the 30 day period, s 464C does not apply’. This is simply confusing the two rules, which are separate.
‘The s 455 tax is based on the lower of the amounts outstanding at the year end and at the end of nine months’. I have seen this ‘mantra’ repeated many times, which even before s 464C might only have held true in a very simple scenario. If, say, Julie’s loan had been cleared by a dividend on 31 May 2015 and she then withdrew £100,000 on 31 July 2015, the lower of the two balances would have been £50,000 but that debt would have been cleared and so no s 455 tax is due. The mantra was unhelpful even before the FA 2013 changes, and is certainly out of date now.

Loan repayments

This brings me to a very important exception to s 464C, though which in itself can be a source of confusion. At s 464(6), it states that the rules do not apply to a repayment which is chargeable to income tax. This can lead to a misunderstanding that the repayment is ignored so, picking up Julie’s case where we left off, if one were to ignore the dividend credited on 31 May 2015 then obviously the balance of £50,000 is still outstanding at 1 August 2015, and s 455 tax would be due. But that is not the case.

As a result of s 464C(6), even if Julie withdraws the same amount on 1 June 2015 the 30 day rule is not in point, or even if on 31 May 2015 Julie had plans to make a further withdrawal the rule at b) above would not apply and that withdrawal would not be matched against the dividend credit. The same would be true if the balance had been cleared by bonus, the logic being that HMRC are already getting their ‘pound of flesh’ because those payments are liable to income tax/National Insurance contributions.

In terms of managing a s 455 liability, problems arise mainly where regular withdrawals are made from the DLA and a repayment is made out of the director’s personal resources or by the transfer of an asset to the company, because those repayments are susceptible to being matched against further withdrawals. It ought to be possible to avoid making further withdrawals within a 30 day period, but the rule concerning arrangements is a different matter. Where regular withdrawals are made from the DLA then at the point in time when the repayment is made there will be arrangements to make further withdrawals and no time limit is placed on this rule, and so if the director draws £500 per week and a repayment is made, there are arrangements in place to draw further sums and so the repayment could be matched against those further withdrawals ad infinitum. This is specifically confirmed in HMRC’s Company Taxation manual at CTM61635:

‘There are no time limits to the application of CTA10/S464C (3).’

As a general rule it may be preferable not to repay overdrawn DLAs out of the director’s own resources unless there are genuinely no plans to make further withdrawals. As noted, where there are regular withdrawals from DLA, at the moment it is impossible to say how far forward HMRC would look in matching repayments with subsequent withdrawals. In those circumstances, perhaps the only time when it is ‘safe’ to introduce funds/assets from the director’s own resources, having regard to s 464C, is at a time when the account is in credit.

Practical Tip :

In order to clear an overdrawn DLA by a dividend or remuneration within the nine month period, this may be ‘paid’ by bookkeeping entries provided that the entries are actually ‘booked’ within that period. There may be a problem in doing so where the company’s records are not kept in standard double entry form and therefore payment cannot be made by bookkeeping entry. In the case of a dividend this problem may be overcome by the company declaring a final dividend which is legally due when declared. It ought similarly to be possible to establish entitlement to a bonus, through a simple board minute (though this will have PAYE consequences).