Be careful when borrowing money from your company as a director – you might fall foul of the ‘bed and breakfasting’ scenario

Directors’ loans – Beware of ‘bed and breakfasting’

It can make sense financially for directors of personal and family companies to borrow money from the company rather than from a commercial lender. Depending on when in the financial year the loan is taken out, it is possible to borrow up to £10,000 for up to 21 months without any tax consequences. However, if the loan remains outstanding beyond a certain point, tax charges will apply.

Company tax charge

In the event that a loan made to a director of a close company in an accounting period remains outstanding on the date when the corporation tax for that period is due, the company must pay a tax charge (‘section 455 tax’) on the outstanding value of the loan. The trigger date for the charge is the corporation tax due date of nine months and one day after the end of the accounting period. The amount of section 455 tax is 32.5% of loan remaining outstanding on the trigger date.

Traps to avoid

In days of old, it was relatively simple to prevent a section 455 charge from applying by clearing the loan balance just before the trigger date and, if the director still needed the loan, re-borrowing the funds shortly after the trigger date (bed and breakfasting). However, anti-avoidance provisions mean that as a strategy this is no longer effective.

Trap 1 – The 30-day rule

The 30-day rule comes into play where, within a period of 30 days of making a repayment of £5,000 or more, the director re-borrows money from the company. The rule effectively renders the repayment in-effective up to the level of the funds that are re-borrowed. Section 455 tax is charged on the lower of the amount repaid and the funds borrowed within a 30-day window.

Example

John is a director of his personal company J Ltd. The company prepares accounts to 31 January each year. In May 2018, John borrowed £8,000 from the company. On 28 October 2019, he repays the loan with money lent to him by his wife. On 7 November 2019, he re-borrows £7,000 from the company to enable him to pay his wife back. He does not make any further borrowings in November 2019.

Corporation tax for the year to 31 January 2019 is due on 1 November 2019. Although the director’s loan is not outstanding on that date, the 30-day rule bites and only £1,000 of the repayment made on 28 October 2019 is effective — £7,000 of the £8,000 paid back is re-borrowed within 30 days. Consequently, the section 455 charge applies to £7,000 – the lower of the repayment and the funds borrowed within 30-days of the repayment – and the company must pay section 455 tax of £2,275 (32.5% of £7,000).

Avoiding the trap

The 30-day rule can be avoided if the company pays the director a dividend, bonus or any other payment that’s taxable and this is used to repay part or all of a loan. In this situation, it’s OK to take another loan from the company within 30 days without the anti-avoidance rule being triggered. Keeping repayments and re-borrowings below £5,000 will also prevent the 30-day rule from biting.

Trap 2 – Intentions and arrangements rule

The ‘intention and arrangements’ rule applies where the balance of the loan outstanding immediately before the repayment is at least £15,000, and at the time a loan repayment is made there are arrangements, or an intention, to subsequently borrow £5,000.

This rule applies even where the new borrowing is outside 30 days. The rule bites if the repayment is made with the intention of redrawing at least £5,000 of the payment, irrespective of when this is done. Again, the rule does not apply to funds extracted by way of a dividend or bonus as these are within the charge to income tax.

Plan repayments carefully

Where looking to repay loans to prevent a section 455 charge from arising, these should be planned carefully to avoid falling foul of the traps.

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This blog explains the most common mistakes that are made in directors’ loan account tax returns.

Directors’ loan accounts – avoiding the risks

HMRC produce a series of toolkits which set out common errors that they find in returns. The hope is that by being familiar with the mistakes that are routinely made, steps can be taken to avoid them. Although the toolkits are aimed primarily at agents, they are useful for anyone who has to complete a tax return. The directors’ loan accounts toolkit highlights the key areas of risk in relation to directors’ loan accounts. The latest version of the toolkit was published in May 2019 and should be used for personal tax returns for 2018/19 and for company returns, for the financial year 2018.

Personal expenses

Expenses are only deductible in computing taxable profits to the extent that they are incurred 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 directors’ personal expenses. Where these are not part of the director’s remuneration package, the company cannot deduct the cost when computing its taxable profits. Instead, they should be charged to the director’s loan account. The director’s loan account toolkit focuses on expenses that do not form part of the director’s remuneration package.

Risk areas

  1. Review of the accounts – any personal expenditure incurred by the director and paid for by the company must be allocated correctly, i.e. an allowable expense where it forms part of the director’s remuneration package and charged to the director’s loan account. Account headings should be reviewed to identify director’s personal expenditure which has not been treated correctly.
  2. 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.
  3. Review of expenses and benefits – where a director is provided with anything other than pay, it may need to be reported to HMRC as a benefit in kind on form P11D. Review 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).
  4. 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”.
  5. Record keeping – good keeping is essential. Poor records may mean expenditure is missed or allocated incorrectly.

Checklist

The toolkit features as useful checklist which can be completed to make sure that nothing is overlooked. The checklist contains a helpful link to HMRC guidance.

Partner note: Directors’ loan account toolkit, see www.gov.uk/government/publications/hmrc-directors-loan-accounts-toolkit-2013-to-2014.

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