Sarah Bradford explains why paying a dividend to clear a director’s loan is not always a good idea.
In a personal or family company scenario, the directors often borrow money from the company. Although this can be useful, tax issues arise where the loan remains outstanding nine months and one day after the end of the accounting period.
Loan not repaid:
If the loan is not repaid within this timescale, details of the loan must be included within the company tax return and the company must pay corporation tax at 25% of the balance of the loan. The tax is due on the normal due date for corporation tax. Interest is charged to the extent that the tax is paid late.
Repaying the loan:
By contrast, if the loan is repaid before the corporation tax due date there is no corporation tax to pay on the loan balance.
There are various ways of clearing the loan, such as introducing funds into the business, writing off the loan, paying a bonus to clear the loan or declaring a dividend. If there are sufficient retained profits to declare a dividend, at first sight this might seem like a good solution.
Anti-avoidance trap:
New rules broadly mean that the repayment may be ineffective in cancelling out the tax charge if a new loan is taken out within 30 days of the repayment, or if at the time that the repayment is made arrangements are in place for a further loan or advance.
Beware the dividend trap:
The extent to which declaring a dividend to repay a director’s loan in order to avoid having to pay corporation tax on the loan balance is a good idea or not depends on whether the director is paying tax at the higher rate. If he is (and assuming he doesn’t have the funds available to introduce into the business to clear the loan), it may be better for tax to be paid on the loan, rather than it being cleared with a dividend.
Repayable tax v non-repayable tax:
Relief can be claimed for the corporation tax payable on the outstanding loan balance when the loan is eventually repaid (or otherwise cleared), but any higher rate tax paid on the dividend is non-refundable.
The corporation tax paid in respect of the loan can be reclaimed nine months after the end of the accounting period in which the loan was repaid. The claim must be made within four years of the end of the financial year in which the loan is cleared.
Example – Avoiding the dividend trap.
Bill is the director of his own personal company (which is a close company). His year end is 31 May. At 31 May 2013, he has a director’s loan account outstanding of £50,000.
Bill’s corporation tax due date for the year to 31 May 2013 is 1 March 2014. He reviews his financial position in February 2014.
He has sufficient retained profits to declare an interim dividend before 1 March 2014 to clear the loan to save paying any tax on the outstanding loan balance. However, he is already a higher rate taxpayer in 2013/14. Assume he pays a net dividend of £50,000 to clear the loan he will have to pay income tax on the dividend of £12,500. This is due by 31 January 2015 and is non-refundable.
Alternatively, the company can pay the tax on the outstanding loan, also £12,500. Although this is due earlier (on 1 March 2014), it can be reclaimed once the loan is repaid (but note that there may be personal tax implications for Bill on the benefit of the loan, if it remains outstanding).
Practical Tip:
If there is the possibility of repaying the loan in the future or declaring a dividend to clear it when the director is a basic rate taxpayer, it may be better to leave the loan outstanding.
