Directors of owner-managed and family companies invariably have a director’s loan account (DLA) where transactions between the director and company are recorded.
At the end of a company’s accounting period, the DLA is usually cleared via a salary allocation (assuming the director is not a salaried director), bonus, dividends, expenses, reimbursements (e.g., company bills paid personally by the director and owed back by the company) or write-off. Dividends are usually preferable because no National Insurance contributions (NICs) are payable.
Salary Vs Dividend
When it comes to choosing between salary and dividend, the best approach taxwise is not a ‘onesize-fits-all’ solution. It heavily depends on the unique circumstances of both the company and the director. Opting for a salary (or bonus) assumes that the company has sufficient cashflow for payment. Invariably, a director will be allocated a salary of £9,100, with the remaining amount to clear the DLA taken as dividends. A salary has the added benefit of being corporation tax-deductible, unlike a dividend. However, a dividend payment may not be feasible if there are insufficient accumulated profits available for payment. In such a scenario, a paid dividend may be considered ‘illegal’, resulting in a debit balance owed back to the company. The director should try to repay this amount before the company’s corporation tax is due (generally nine months after the year end), because if left unpaid, the company is liable to an additional tax charge of 33.75%.
In certain circumstances, the director may also be liable to pay additional tax under the ‘benefitsin-kind’ rules. This liability is based on the cash equivalent of interest payable at the official rate should the loan exceed £10,000 at any time during the accounting year. If the £10,000 threshold is exceeded, the entire loan becomes chargeable, not just from when the excess was incurred. No employee’s NIC is chargeable, although employer’s NIC is payable (unless employment allowance is available). If interest is paid on the loan, the company will not be liable for the additional payment. With current bank loan interest rates at an average of 6.9%, it would be financially beneficial for the director to borrow from the company and suffer the interest charge at 2.25%.
A director does not have to take the salary declared for them; this is another way to reduce an overdrawn DLA. The director is owed a salary that has not been withdrawn and the intended salary payment is deducted from the overdrawn amount owed.
In cases where the company has two directors (e.g., a husband and wife) and one director owes money to the company while the other is owed money, offset can be applied. To enable offset, the directors must formally agree in writing and proper documentation must be kept and retained for future reference. This ensures transparency and compliance with financial regulations.
Planning With Pensions
Word amongst independent finance advisers is that the new Chancellor is considering restricting the tax relief on pension contributions to 33% for higher and additional rate taxpayers and increasing to 33% for basic-rate taxpayers. Clients should always consider their future pensions, not least as the state pension triple lock could be suspended as it was in 2021.
Assuming a taxpayer has ‘spare’ savings, one taxefficient method of clearing a director’s loan is by making a capital deposit. That deposit can then be used to clear the DLA, and the company makes a pension contribution on the director’s behalf before the company’s year end, thereby receiving corporation tax relief. Care is needed to ensure that the balance of personal allowances and the £500 dividend allowance are retained.
Practical Tip
HMRC becomes aware of repayable loans by reviewing the accounts accompanying the annual corporation tax return on submission. A negative balance in the company’s reserves is an obvious flag.