Be careful what you take out of your business warns insolvency expert
Sheffield insolvency expert Stephen Beverley is warning company directors of the dangers of failing to understand all the implications of the way they pay themselves.
Directors can draw their money from a company in several ways, including salary, dividends - if also a shareholder - or directors’ loan.
But the drawback of taking that money as a loan is that it can lead to complications at the end of the financial year.
Section 455 of the Corporation Tax Act 2010 imposes a tax charge when a company lends money to or advances credit to a director or shareholder.
That means there will be a tax charge if the loan is not repaid by the end of the company’s accounting period in which the loan was taken out.
“Although it might sound complicated, what this system means is not so difficult to understand,” said Stephen, a director with the Sheffield office of professional services group Leonard Curtis.
“A simple example would be that if a company lends £10,000 to a director and that loan remains outstanding at the company’s year end accounts, then there will be a tax bill of £3,375 under the terms of the Section 455 rule.
“If the director does eventually pay back the loan after that period, the company can reclaim the tax - but only nine months and one day after the accounting period in which it was repaid, which is a potential 21 month delay.
“The aim of Section 455 is to disincentivise directors from taking that money as a substitute for salaries or dividends and thinking there is nothing to worry about and, of course, short term loans that are fully repaid within the permitted period usually avoid any charge.
“It should also be pointed out that re-paying and immediately re-borrowing to avoid tax can ultimately be challenged under HMRC anti-avoidance rules.”
Stephen stressed that there is nothing wrong with a directors’ loan but that it was important to fully understand the implications of the arrangement.
“It is very important if you do go down this route to factor it into cash flow forecasts for future months because if it you do fall into the terms of Section 455 there will be a cost implication that HMRC will pursue and that could impact negatively on the business in the long term,” he said.
“Potential funders might see any evidence of it as a sign of poor financial judgement.
“That’s why I would also say that if there is any doubt at all, you should seek proper advice.
“This is especially important with the current tax environment we are facing or if there is any doubt the loan can be repaid in full.
“It’s important to ask yourself if you are taking into account all the things you need to when you are taking money out of the business if you want to avoid setting a trap for yourself in the future.”