HMRC has updated its agents’ tool kit relating to directors' loans.
This is aimed at helping and supporting tax agents and advisers by providing guidance on the errors which commonly occur. The guidance refers mainly to the effect on the individual’s tax return. However, it may also be helpful to anyone who is completing a company tax return.
Although it is not compulsory for ACCA members to follow this kit, it is very important that they are aware of its contents as it effectively gives HMRC’s ‘view’ on the risk areas. In other words it clearly shows the areas that HMRC is concerned about.
The update was released on 9 May 2017 so now is a good opportunity to review this important area in conjunction with HMRC’s publication.
The tool kit takes the form of a checklist which the agent is encouraged to fill in when they are dealing with a tax return for a relevant client. The relatively straightforward questions have a YES, NO or N/A answer which doesn’t provide too much of a problem. However, don’t switch off just because these seem to be obvious. The areas that are of most interest are contained in their guidance on risk areas. These make it clear that agents should be thinking about some general areas (guidance is set out before the checklist) and some specific areas (set out after the checklist).
We have summarised the major risk areas:
Wholly and exclusively A company may not deduct expenditure in computing its taxable profits unless it is incurred wholly and exclusively for the purposes of the trade. As companies are separate legal entities that stand apart from their directors and shareholders they do not incur personal expenses. However, many companies, particularly 'close' companies, pay for personal expenses of the directors. It is important to note that where payments, either made to or incurred on behalf of a director, do not form part of their remuneration package, these amounts may not be an allowable company expense. In such circumstances it may be appropriate for these items to be set against the director's loan account. Establishing whether a payment forms part of a director's remuneration package can be complex.
The kit then directs the user to the enquiry manual which gives their opinion on the above. If you follow this link you will see that the language in the manual is suddenly more robust. For instance the enquiry manual starts off with the strong statement:
In close companies, there is a strong possibility that the business will be used to pay private expenses of the owners.So it’s clear that agents need to make sure that their clients are aware of the differences between private v business expenses and how these are declared.
Personal expenditure The second risk area follows on from the above so this is clearly the focus. There are two points made:
It is important that any personal expenditure incurred by the director and paid by the company is allocated correctly. Where the expenditure forms part of the remuneration package it will be an allowable expense of the company and the appropriate employment taxes should be paid. Note that this emphasises the approach recently taken by HMRC to encourage employers to payroll benefits and personal expenditure.
A review of particular accounts headings may identify directors' personal expenditure that has not yet been allocated appropriately. Transactions should normally be recorded as they occur and a detailed transaction history maintained, so that it is possible to identify the director's loan account balance on any given date. If transactions are not posted at the time they occur, for example if they are only posted at the year end, an overdrawn balance during the year may be overlooked.
Many small companies will only have their records ‘officially’ written up once a year as part of the annual accounts preparation. So HMRC is pointing out that the balance of the DLA should be known on any given date rather than once a year as part of a separate exercise.
It also highlights the risk that credits to the DLA need to be calculated properly as clearly these could be used to reduce any overdrawn balance:
If transactions are not posted at the time they occur, for example if they are only posted at the year end, an overdrawn balance during the year may be overlooked.
With the additional requirement of making tax digital coming our way soon, it is important that clients are aware of their record keeping responsibilities. Remember that the statutory accounting records that need to be kept are:Companies Act 2006 s.386 Duty to keep accounting records
Every company must keep adequate accounting records.
Adequate accounting records means records that are sufficient— (a) to show and explain the company's transactions, (b) to disclose with reasonable accuracy, at any time, the financial position of the company at that time, and (c) to enable the directors to ensure that any accounts required to be prepared comply with the requirements of this Act (and, where applicable, of Article 4 of the IAS Regulation).
Accounting records must, in particular, contain— (a) entries from day to day of all sums of money received and expended by the company and the matters in respect of which the receipt and expenditure takes place, and (b) a record of the assets and liabilities of the company.
If the company's business involves dealing in goods, the accounting records must contain— (a) statements of stock held by the company at the end of each financial year of the company (b) all statements of stocktakings from which any statement of stock as is mentioned in paragraph (a) has been or is to be prepared, and (c) except in the case of goods sold by way of ordinary retail trade, statements of all goods sold and purchased, showing the goods and the buyers and sellers in sufficient detail to enable all these to be identified.
Loan accounts Commonly, but not exclusively, loans or advances are made to directors of close companies through their loan accounts. Where a director (who is also a participator) has a loan account that is overdrawn this should be reviewed to consider whether the company is liable to pay S455 tax.
The above sounds obvious but HMRC is emphasising the point that overdrawn loan accounts may be treated the same as direct loans. Again the record keeping may have a bearing on this.
S455 tax does not apply to directors who are not also participators and
only applies if the company is a close company at the time the loan or advance is made.
Normally each director has a separate loan account; indeed each director may have more than one account. Where there are separate accounts for individual loans/indebtedness each account should be considered separately for S455 purposes even where the loans are to the same person. If accounts are aggregated inappropriately this can result in an underpayment of S455 tax. The position, however, is different if the facts show that there is genuinely a joint account. It would, though, be unusual to find two directors operating a genuine joint account unless they are spouses, civil partners or otherwise closely related individuals.
The clear risk being that one director’s DLA balance is offset against another to reduce/avoid S455. Agents should ensure that records are kept of all individual balances and that (where necessary) the directors should confirm these in writing to evidence agreement on contentious entries/issues.
Feedback HMRC would like to hear about your experience of using the toolkits to help develop and prioritise future changes and improvements. HMRC is also interested in your views of any recent interactions you may have had with the department.