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Mark McLaughlin CTA (Fellow) ATT TEP highlights a potential problem with overdrawn directors' loan accounts. 

Deliberate but not concealed?

The new penalty regime for incorrect tax returns affects income tax, corporation tax, VAT, PAYE and other returns, for periods from 1 April 2008 which are due to be filed after 31 March 2009, and is therefore now generally upon us in terms of personal and company tax returns for current periods.

A recent article in the ICAEW’s Taxline highlighted examples in HMRC’s Compliance Handbook of ‘deliberate but not concealed’ inaccuracies, which could attract penalties in the range 20% to 70%. Paragraph CH81150 gives the following example:  

“deliberately withdrawing money for personal use from an incorporated business and not making any attempt to make sure it is treated correctly for tax purposes.”

In practice, the owners of many small, owner-managed companies often withdraw funds during the accounting period, resulting in an overdrawn director’s loan account. This overdrawn balance is then normally cleared by bonus or dividend, perhaps before the end of the accounting period, or within the following 9 months.

Is that so…?

There is a statutory requirement for employers to apply PAYE to relevant payments made to an employee during a tax year. However, notwithstanding any company law issues, there seems to be nothing in the tax statute that treats any withdrawal of funds by a company shareholder as a culpable offence.

If a company owner regularly withdraws funds resulting in an overdrawn director’s loan account, which is cleared by a bonus every year, it is not difficult to envisage HMRC arguing that an offence has been committed (if, for example, this results in a late PAYE return), with a view to imposing a penalty. However, if the loan account is regularly cleared by dividends, it is difficult to see how HMRC could impose a penalty in such circumstances. 

Avoiding the issue

Of course, in practice it may be difficult to prove that funds have been withdrawn from the company in the capacity of a shareholder, rather than as a director or employee. If a business owner receives a combination of salary (or bonus) and dividends, it may be advisable to keep separate loan accounts for the same individual, to demonstrate the capacity in which each withdrawal has been made.

In view of HMRC’s comments in CH81150 (even if they are brief and not altogether clear), it would be prudent to avoid overdrawn loan accounts if at all possible, particularly where it appears that funds have been withdrawn on account of a salary or bonus. It will be interesting to see the extent to which HMRC apply the guidance in its compliance handbook. In the meantime, clients should be made aware of HMRC’s view on penalties in respect of company withdrawals.

The above article is reproduced from 'Practice Update' (January/February 2009), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past copies, visit: http://www.markmclaughlin.co.uk/index.php/archives/category/about/newsletters)