As a director, the company may pay for personal expenses from time to time. You can clear the debt by repaying it or get the company to write it off. Does it matter how and when you do this?
By Simon Denye, Partner, Dow Schofield Watts Tax Consulting LLP
Your company card has paid for goods and services which are personal expenses. These costs have been added to your director’s loan account and you now owe your company over £10,000. This figure is significant because owing more than £10,000 counts as a taxable benefit for you, and your company must pay Class 1A NI. Plus, if the debt isn’t repaid within nine months of the end of your company’s financial year, it will have to pay tax equal to 32.5% of the amount owing.
Avoiding the tax charges – key dates
If you pay interest at HMRC’s official rate (currently 2.5% simple per annum) on the average amount you owe over the tax year, you’ll avoid the income tax charge.
What’s more, if you pay the interest no later than 5 July following the end of the tax year, your company won’t have to pay Class 1A NI. But the only way to avoid the 32.5% tax on your company is to clear the debt within nine months of the company’s financial year end.
Increasing income tax efficiency
Repaying the debt not only eliminates the 32.5% tax but reduces the income tax and Class 1A charges. There’s a neat timing trick you can use to increase tax efficiency.
Example. At the start of 2018/19 I owed my company (which has a financial year end of 31 March) £1,000. By mid-March 2019 I owed £25,000. The whole debt is repaid on 25 March so that the 32.5% charge is avoided. The average debt is therefore £13,000 ((£1,000+ £25,000)/2) and this is the amount on which the taxable benefit for me is worked out.
Tip. If instead only £24,000 of the debt is repaid in March and the remaining £1,000 after 5 April 2019, the average loan on which the income tax and NI is calculated is just £1,000 ((£1,000+ £1,000)/2). The 32.5% company tax is still avoided as repayment was made within the nine-month window.
Trap. HMRC can use an alternative to the average balance method to work out the taxable amount and so increase the income tax and NI bill, but it’s rare.
Repay or write off
Rather than you repaying the debt the company could waive it and write it off. This can be done in two steps to achieve the income tax and NI efficiency explained above.
While writing off a debt counts as taxable income, for director shareholders (but not employees or director shareholders who don’t own or control at least 5% of their company’s ordinary share capital) it’s taxed in the same way as a dividend.
NB Unlike a dividend, a debt can be written off even if your company doesn’t have accumulated profits equal to or greater than the debt. Just make sure that you have the right paperwork in case HMRC asks questions
The most tax-efficient way to write off or repay money you owe your company is to do it in more than one step. This reduces the amount of taxable benefit in kind. Repay or write off most of the debt a few days before the tax year end and the balance within nine months following the end of the company’s accounting year.
Simon is a Partner in Dow Schofield Watts Tax Consulting LLP. He has over 21 years’ experience providing advice to a wide range of clients including large corporates, SMEs and high net worth individuals.