Anybody still want to disagree? - "Directors of small companies should be made aware that loans in excess of £5,000 are illegal"

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Tax under s419 TA88
Two very similar questions were asked in early February 2007. On 6
February Lorraine Jones introduced the situation where a company
client had overdrawn directors' accounts, and the balances were not
repaid within nine months, thus incurring tax under section 419, Taxes
Act 1988.

Lorraine uses Taxcalc Pro, which calculates the tax and enters it on
Form CT600. However, no tax computation is produced, unlike for SA
100, so that the firm normally produces its own tax computation and
sends it with the return. Should the additional information regarding
the section 419 liability be shown on the tax computation ***? Is
there a standard wording for it? She would rather not have the forms
returned by HMRC because the details were not in the correct format.

There were 15 replies to this particular query. Dean Shepherd usually
places the section 419 memorandum at the foot of the computation,
similar to a loss memorandum. Claims for a return of the s419 tax are
made separately from the CT600, so that there is no requirement to
record the figures on the tax computation. Entries are really made
only for the accountant's benefit.

Euan McLennan agreed with this analysis. However, the main problem
with s419 tends to be the timing of the refund under s419(4), when
there is a total or partial repayment of loans in the following year's
company accounts. He would keep a spread*** showing the payments and
refunds, so that all the s419 tax is eventually claimed back. There is
also the question of disclosure in the company accounts. Opinions are
divided between:




showing the s419 tax as a current liability and tax charge in the
company accounts when the directors' accounts become overdrawn, and
recognising the tax recoverable as a current debtor and reduction of
tax charge in the accounts when the loans are repaid; and

recognising the eventual refund as an asset (not due within one year)
in the same accounts as the tax liability when the directors' accounts
go overdrawn, with no effect on the tax charge.
Euan favours the first option, because the tax refund can only be
recognised as an asset when the loans have actually been repaid.
Others take the view that the s419 tax is no more than a refundable
deposit via HMRC, even though the company has no right to demand the
refund until the directors' accounts are restored to credit in the
future.

Jessica Hart reminded Lorraine not to forget the accounting entries.
In addition don't forget to declare a benefit in kind on the P11D and
Class 1A NIC liability, unless the loan is less than £5K. And, of
course, remind the client that a loan to a director is illegal under
the Companies Acts!

Euan followed this up by stressing that a loan under £5K is not
illegal under the Companies Acts. The benefit in kind is the
difference between the interest actually charged on the loan and
interest at the official rate of 5%. In reply to a point raised by
James Spearink, Euan referred to section 420, TA 1988. This provides
that no section 419 tax is imposed on loans of up to £15,000 to
directors where the director works full time for the company, and has
no material interest in the company. This situation will be very rare.

Richard Joseph stressed that section 419 tax is not imposed unless the
overdrawn account has not been repaid within nine months of the year
end. A properly declared dividend credited to the director's loan
account would fulfil the obligation. Technically, section 419
imposition is not corporation tax, although shown on the computation
and form CT600. Section 421 refers to it 'as if it were corporation
tax'. If it were corporation tax, automatic repayment would not occur
when the loan is repaid.

Lorraine then disclosed that the two directors' loans at the year
ended 31 March 2006 were £14,068 and £10,003. Nine months after the
year end at 31 December 2006 the figures were £1,664 and £5,868.
Section 419 tax was calculated on £5,868. In reply to further
questions that she asked, Euan McLennan replied as follows:




The forms P11D for 2005/2006 should have reported the average monthly
overdrawn balance on each of the two loan accounts.

Amended P11Ds and amended personal self assessment tax returns for
2005/2006 will have to be submitted, as Lorraine did not have the
requisite information when dealing with these returns.

It may or may not be necessary to submit amended company accounts to
Companies House, depending on whether it is considered that the
necessary entries are material, and also whether Lorraine used the
first or second of the two bases that Euan mentioned earlier.

As the loans had increased again in 2006/2007, the necessary entries
will have to be made in the P11Ds and SA tax returns.
I have to say that this query is a cautionary tale. However, it is
extremely difficult to persuade owner controlled company directors
that company monies do not belong to them personally, and that they
can do what they like! In theory at least:




Directors of small companies should be made aware that loans in excess
of £5,000 are illegal and have tax consequences.

They should also be informed that section 419 tax and a benefit in
kind charge will result if they offend in this way.

If at all possible the accountant should keep a checklist of small
company clients, with the purpose of ascertaining the director's loan
accounts position at the year end. Remedial action can then be taken
by repayment, perhaps by dividend, within nine months of the year end.
This will not, however, affect the P11D entry for the previous year in
many cases.

A spread*** should be kept of the section 419 position when loans
are taxable, with the purpose of making sure that tax is reclaimed
when loans are repaid.
I realise that these suggestions are somewhat 'pie in the sky' as,
unfortunately, business life is far from perfect.

Cathy Ratchford asked a similar query about the P11D limit for a full
time working director of a company, in which he or she had a material
interest, in her query of 13 February 2007.

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