The Owner-managed business & overdrawn DLA account
Small business owners often use the Directors Loan Account (“DLA”) as a means of extracting funds from their companies throughout the year to top up a minimum salary withdrawn. The resulting overdrawn DLA is then typically paid off at the year-end through the issue of a dividend when the full extent of profits for the period is known.
There are different options and tax implications for clearing a DLA even when there are insufficient reserves to declare a dividend to pay off the balance owing.
In any normal year this does not normally cause problem for the profitable company: however, as we now know, 2020 is not a normal year. Where a company does not have sufficient distributable profits (i.e. P&L reserves) to declare a dividend this can create its own tax problems.
So what are the options for any business owner with an overdrawn DLA where there are insufficient distributable reserves to declare a dividend to repay the DLA balance at the year end?
- Leave the DLA overdrawn
Leaving the DLA overdrawn creates tax charges for the owner and the company where the limited exceptions from the charge do not apply.
Using an example with a hypothetical business and owner: George Lazenby, sole director/shareholder in Bond Ltd withdrew £30,000 from the company during the year on top of his minimum salary but unfortunately Bond Ltd had no distributable reserves at its year ended 30th September 2020 to pay that extra as dividends. Unless his DLA is repaid by 30th June 2021, Bond Ltd would have to pay HMRC 32.5% of the outstanding loan i.e. £9,750.
Any such payments made to HMRC on overdrawn DLAs can be reclaimed once the overdrawn DLA is cleared. However, this reclaim can only be made nine months after the end of the accounting period in which repayment is made and so can create its own cashflow issues. If Bond Ltd were able to pay George a dividend to clear the DLA account by 30th September 2021 the earliest that Bond Ltd could reclaim the £9,750 from HMRC would be on 30th June 2022.
Do also note that there is a different set of rules that create benefit in kind implications of an overdrawn DLA exceeding £10,000 provided on an interest free basis. On the above figures that £30,000 loan will result in an annual income tax cost on George of £135, and a Class 1A national insurance charge on the company of £91.
- Repay the DLA
If the director shareholder has sufficient personal funds and does not fall into the exceptions from the 32.5% payment, it is most tax efficient to repay the overdrawn DLA balance within 9 months of the end of the accounting period to avoid the company tax charge altogether. That payment may itself be from tax-paid funds so there may overall be little different in overall tax cost to declaring a dividend to clear it.
- Write off the DLA
The company could write off the outstanding loan. That will result in its own tax implications. The loan written off will be taxable as a dividend on the shareholder, taxable at their dividend rates of Income Tax (somewhere between 0% and 38.1%). If the shareholder is also an employee or office holder then Class 1 NIC (both employers and employees) will be payable on the dividend received.
If George was a basic rate taxpayer (and assuming he had used his personal and dividend allowance in the year) the Income Tax payable by George on a £30,000 dividend would be £2,250. As George is a director shareholder of GE Ltd, there would also be Class 1 NIC payable of £3,600 by George and £4,140 by GE Limited.
The writing off of the DLA balance is not a tax allowable expense for the Company but the employers class 1 NIC will be.
Care must also be taken to ensure that the company is solvent before agreeing to waive the DLA balance otherwise any future Liquidator of the Company could seek to recover the debt written off and this could risk the personal assets of the shareholder if they are unable to pay the debt at that point.
- Pay a bonus to clear the DLA
An alternative option available would be to declare a bonus to the director shareholder to clear the overdrawn DLA balance where there are insufficient reserves.
There will be income tax and Class 1 NIC payable on the value of the bonus paid to clear the DLA balance. However both the bonus and employers class 1 NIC will be an allowable expense of the Company.
This may not be as tax efficient overall as writing it off or paying dividends, but the whole picture should be looked at including not just the overall tax but also the timing of payments and relief.
Ultimately the most tax efficient route will be dictated by the size of the overdrawn DLA and the tax position of the shareholder. If you find yourself in this situation and would like advice on how best to proceed or if you would like advice on a tax efficient mix of salaries and dividends please do not hesitate to contact the Business Tax team at Garbutt & Elliott LLP by emailing email@example.com.