As a shareholder if you owe your company money it might result in an extra tax charge. This can be avoided by clearing the debt with a simple book entry or as a transfer of the cash required, but which is the best option?
Shareholder’s debt
In certain circumstances, where a shareholder owes money to the company in which they own shares it has to pay additional tax known as a s.455 charge. The charge is equal to 32.5% of the debt. The most common situation where the charge occurs is where a director’s loan account (DLA) is in the red. The good news is that the tax charge can be avoided relatively easily.
Repayment clears the tax bill, but then…
You might already know that if a debt you owe your company at the end of the accounting period is repaid within the next nine months the s.455 charge won’t apply. The trouble is that while repayments reduce the charge, tricky anti-avoidance rules can prevent this.
Trap. There are two rules to watch for. The first applies if you repay £5,000 of what you owe and within 30 days you borrow £5,000 or more. Some of the repayment won’t count towards reducing the s.455 charge. The second rule applies if you owed £15,000 or more, you repay some or all of it at any time (there’s no 30-day limitation) having previously arranged to borrow more money in effect reimbursing you wholly or partly for what you repaid.
Example. Tim is a director shareholder of Acom Ltd. Its financial year ends on 31 March. In the year to 31 March 2019 Tim built up debts in his director’s loan account of £25,000. If any part of this remained owing beyond 31 December 2019 Acom would be liable to a s.455 charge at 32.5% of the uncleared debt. On 1 October 2019 Acom pays a dividend of £12,000 into Tim’s bank. On 20 December Tim repays £10,000 to Acom to reduce the s.455 charge. On 1 March 2020 Tim borrows £6,000 from Acom. He knew when he repaid the £10,000 that he was going to borrow more in the near future. Therefore, the second anti-avoidance rule applies. The lesser of the repayment (£10,000) and the new borrowing (£6,000) is therefore ignored and the s.455 charge applies to £21,000 (£25,000 – £10,000 + £6,000).
Book entry dividend
The good news is that the anti-avoidance rules include a quirky get-out clause.
Tip 1. If instead of Acom paying the dividend to Tim’s bank it credited it to his DLA, the anti-avoidance rules won’t apply. So while the dividend reduces the amount liable to the s.455 charge (by £12,000) it doesn’t count as a repayment for the purpose of the anti-avoidance rules. This means Acom will only have to pay s.455 tax on £13,000 instead of £21,000. This might sound too good to be true but don’t take our word for it, the legislation and HMRC agree (see The next step ).
Tip 2. The anti-avoidance rules wouldn’t bite even if Tim borrowed more from Acom after the dividend has been credited to his DLA to put him financially in the same position as if Acom had paid the dividend to his bank.
A dividend paid to a director which they use to pay off an amount owed to the company reduces the extra tax charge. Crediting the dividend to the director’s loan account achieves the same result but without the risk of the anti-avoidance rules reinstating the tax charge in the event the director borrows more.