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Overdrawn Directors Loan Account: Penalties

Directors can borrow money from their company, but HMRC imposes a limit of £5,000 per director before there are tax considerations at play.

directors loan

If a director borrows money from their company (in effect overdraws the profits) and doesn’t repay this loan within nine months of the company year end then the company is required to notify HMRC on its tax return and pay tax at 32.5% of the balance to HMRC.

This notification needs to be made 12 months after the end of the financial year.

Directors Loan Repayments

It is relatively easy to assume that the repayment has been made from the next years dividends. However, care needs to be taken over the timing of such a dividend award and the directors’ drawings in the next year up to the date of the dividend declaration need to be taken into account in calculating the balance.

When the loan is repaid after the nine months have passed, the company will notify HMRC on the next company tax return of the repayment and request repayment of the tax. This only repays nine months after that next year end as there is no early repayment of the tax.

So, it’s quite easy to fall into the trap of thinking that if this process isn’t correctly notified there will just be interest to pay to HMRC as the effect is tax neutral over the two years.

When a Directors Loan Penalty is Triggered

However, the main purpose of this article is to warn people that this is not the case. This situation dealt with incorrectly can trigger a “failure to notify” penalty from HMRC.

For example, HMRC can pick this up on an investigation when at least 12 months have passed since the filing deadline. Even if they deem that the error was not deliberate, a penalty levy of 20% of the tax that was due can be made (even though the tax is subsequently repayable so no loss to the HMRC).

This can obviously result in some quite significant penalties for companies in this situation. The penalty is reduced to 10% if the error is disclosed to HMRC without them opening an investigation. So, if you think you have missed out on declaring overdrawn director loan account balances to HMRC, consider rectifying this sooner rather than later.

Count On Cardens

As ever please contact the Cardens team if you need assistance in this area.

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