Getting money out of your business in the most tax efficient way is a common challenge in owner managed businesses.
The most common scenario is Directors taking money out in lump sums or regular amounts and at the end of the year these amounts are formalised by the company’s accountants as either Dividends, Remuneration or Loans.
What are the pitfalls?
Section 455 Tax
If there is a loan outstanding at year end and 9 months after the year end then the Company is liable to pay 32.5% of this balance to HMRC.
This comes under the ‘loans to participators’ tax charge (CTA 2010 s 455).
Tax can be repaid once the loan is repaid.
Also, there are anti-avoidance rules to block a practice commonly known as ‘bed and breakfasting’, where the loan is repaid but another loan is taken out shortly afterwards.
But wait there is more….
Beneficial Loan Interest
Section 455 tax isn’t the only potential tax due.
If the Directors Loan Account is overdrawn there is also tax on ‘beneficial loan interest’ if interest is not paid at the ‘official rate’.
The interest not paid is treated as a perk of the individual’s employment with the Company. Income tax arises on the individual, National Insurance on the company and a requirement to submit P11D return to HMRC.
A lot of these pitfalls can be avoided if they are ‘characterised’ at the time. Rather than simply taking money out and clearing the balance at the end of the year it is better practise to indicate what the amounts are for.
Try and have accounting records that indicate the amount of ‘distributable’ profits available so that you don’t get into a situation where your ‘Directors Loan Account’ is overdrawn.