Company Tax Relief - What is a DLA?

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1 .1. INTRODUCTION (DLA) simply describes the situation where either the company owes a director money or vice versa. Typically, a DLA is first created shortly before a company first starts to trade where the shareholders/directors put money in as start-up capital. The company now owes the directors. Of course, where the director draws money from the company which is not earnings or dividends, it will reduce the debt the company owes or make their DLA overdrawn. Monetary transactions between a director and their company should be reflected in their DLA in the company s bookkeeping records. It might be appropriate to set up more than one DLA for the same director, for example where the company makes a fixed loan with fixed repayments to a director who also has day-to-day transactions with the company, e.g. they incur business expenses on behalf of their company for which they are later reimbursed..2. CHARGING EXPENSES Business expenses are a common example of a transaction which will show up in a DLA. Simon, who is a director of his company, spent 700 of his own money entertaining business customers and fills in an expenses claim. But because all of the company s spare cash is tied up in working capital, Simon decides not to draw the 700 from the company just yet. However, because he s spent money on company business he knows he can credit the sum to his DLA and charge the corresponding expense to entertaining in the accounts. The 700 is now owed to Simon and he can claim it at a later date. By crediting an amount to your DLA you can simply withdraw the cash tax-free at a later date. If you are a little short on cash, but your company is in funds, it s perfectly legal for the company to pay for your personal expenses, e.g. the cost of your summer holiday, as long as you transfer the costs to reduce your DLA and not try to pass them off as a business expense. But, remember, this is only a temporary solution as the loan will have to be repaid. 123

2 .2.1. Practical points You must have adequate records to show the nature of an expense otherwise where it is charged to your DLA and you can t show HMRC that it was for business, you will have to pay tax on it. For example, if you ve paid out to entertain a business customer you should keep receipts, bar bills, credit card vouchers etc. This may seem like a chore, but it s a necessary one. However, there are no special rules to worry about. The documentation kept in support of your claim forms part of the company s books in the same way any other expenses invoices do. Unlike putting an entry on your tax return or on a P11D, these claims are not separately identifiable from the rest of the company s day-to-day expenses which will eventually appear in the annual accounts. This doesn t mean they won t ever be queried by HMRC. They could be picked up or challenged through an enquiry into the company s tax return or on a compliance visit What type of expenses can you credit to your DLA? The simple answer is: anything and everything. And as long as it has been wholly and exclusively incurred for the purposes of your company s trade it won t result in a tax bill and usually won t be subject to NI either. This doesn t mean that nonbusiness expenses can t be charged to your DLA; it simply means that if they are you will have to pay tax and some NI on them..3. CHARGING INTEREST ON A DLA When the company borrows from a bank it must pay interest on the money advanced. If you have a DLA with the company that s in credit, i.e. the company owes you, it s a loan and you can ask the company to pay you interest. Whether or not you can be paid interest will depend on several factors, for example, whether the company can afford to pay interest and whether any other director shareholders agree to it. However, where interest can be paid it s a tax (actually NI) efficient way to draw income as your company can claim tax relief against its corporation tax (CT) bill on whatever it pays you and it isn t liable to NI. Mr F is a 75% shareholder of Full Security Service Ltd. Over the years he has ploughed back part of his dividend income to provide working capital for his company. Throughout the company s year ended 31 December 20 the balance outstanding on his loan account with the company was 100,000 on which he charged interest at the rate of 6% per annum. Interest due 124

3 to him from the company is therefore 6,000. His company pays CT at the rate of, say, 20%. So being able to include this interest in its year-end accounts would reduce its CT bill payable on 1 October The tax position for the company and Mr F is as follows: Company Taxable profits before interest 0,000 Less interest charge (6,000) Taxable profit after interest charge 144,000 Corporation tax (CT) at 20% (28,800) Profit after tax 1,200 Company tax saving on interest 6,000 x 20% 1,200 Mr F Interest received net of tax deducted by the company 6,000 less 1,200 ( 6,000 x 20%) deducted by the company Less income tax payable 6,000 at 40% = 2,400 less 1,200 tax deducted at source by the company 4,800 (1,200) Net amount received 3,600 A company normally obtains a tax deduction for interest charged in its accounts on an accruals basis, i.e. the amount charged against its profits. So it can claim a tax deduction for interest accrued for the shareholder but not yet paid. However, a loan between a close company, (one that s controlled by five or fewer individuals) and a shareholder, or an associate of a shareholder, is subject to the late interest rule. This means that the CT deduction for any interest that remains unpaid more than twelve months after the accounting period end is deferred until interest is actually paid. So the company will get relief for the interest on a loan from a shareholder on an accruals basis if it is paid within twelve months after the end of the relevant accounting period. The company will obtain tax relief for the year ended 31 December 20 provided the interest is paid to Mr F by 31 December However, CT relief will not be given if the interest is simply rolled up as a credit to his loan account and remains outstanding at 31 December The recipient director shareholder is taxed on the gross interest received, with credit being given for any tax deducted at source by the company. Note. Companies are required to deduct tax at 20% from interest it pays to an individual. 125

4 There s no employees NI due on interest paid to you by the company, as it doesn t constitute earnings, as long as the rate used is not in excess of a commercial one Paying the interest 1. The interest can be paid by cheque or by electronic transfer to your personal bank account or credited to your DLA (thereby increasing the balance owed by the company to you). 2. The payment can be made on a regular basis, either monthly or quarterly, or annually if you wish. However, as the company has to tell HMRC how much interest it has paid to you each quarter, it may be convenient for it to pay the interest due to you on the same basis. 3. In order to help you with your tax affairs the company should issue you with an annual certificate of interest for the relevant tax year. The commercial rate could be several points above bank base rate. This would recognise that it may become a risk if the company gets into financial difficulty. 4. The company should pay a commercial rate of interest on the money it has borrowed from you. This may be 5% or 6% over the bank base rate. However, if the company pays more than a commercial rate, HMRC has powers to cancel any resulting tax advantage you achieve Tax return entries The interest you receive from the company must be shown on your tax return, under Income from UK savings and investments. You should copy the amount of net interest paid from the certificate provided by the company, to your tax return. You are also required to enter the amount of tax deducted and the gross amount of interest paid before tax Can you deduct any expenses from this interest? No, not directly. However, if you borrowed from a bank so you could lend the money to your company, the interest you re charged is tax deductible against your income in general, but only if the following conditions apply: 126

5 1. The company must be a close company which means it is controlled by its directors or there are five or fewer shareholders. 2. The company must either be trading or control a company that is trading, or it must hold land that is let to someone connected with the company. 3. You must own at least 5% of the company s shares or be able to control at least 5% of the shares through your relatives or associates at the time the interest is paid At what rate will your interest be taxed? The tax you pay on interest received from the company will depend on the level of your other income in the same tax year. The interest is taxed after taking account of salary/bonuses but before adding dividends to your total income. If the company has already deducted income tax at 20%, you don t have to pay any further tax as a basic rate (20%) taxpayer. If you pay tax at a higher rate, e.g. 40%, you will have to pay further income tax at the rate of 20% on the interest received. If your rate of tax is 45% you will have further income tax of 25% to pay..4. OVERDRAWN LOAN ACCOUNTS Let s say you take a modest monthly salary from your company and receive an annual dividend once the profit for the year is finalised. But when large bills crop up, such as car repairs or a holiday deposit, the company picks up the tab and charges the cost to your DLA, which causes it to slide into the red for a few months. When your loan account goes overdrawn by more than 10,000 ( 5,000 prior to 6 April 2014), HMRC says that you might be benefitting from an interest free or cheap rate loan. To avoid a tax charge on this benefit you can pay interest on the loan at HMRC s official rate, 3% per annum from 6 April 2016, 3.25% from 6 April 2014 and or 4% before then. If you opt not to pay interest the taxable benefit is worked out as follows: Say your DLA is overdrawn by,,000 for six months between 6 April and 5 October 20, interest at the official rate is 225 (,000 x 3% x 6/12). This amount counts as income on which you must pay tax at the rate applicable to you. If you re a 40% taxpayer the tax payable is 90 ( 225 x 40%) - not too much to worry about. However, your company is also stung with Class 1A NI at 13.8% of the benefit, i.e. which totals 31 ( 225 x 13.8%). 127