Failing to record directors’ loans can prove costly
Directors’ loan account (DLA) adjustments are a constant theme in the accounts of SMEs. Practitioners are often faced with the task of analysing SME transactions and explaining which credits should/should not go to the DLA.
Often the directors/shareholders adopt an informal approach and are rather keen to process entries which benefit them but often do not understand the implications. The directors of SMEs, mainly due to the size of the business, necessarily tend to concentrate on day to day activities and pay less attention to accounting and tax matters.
This often results in HMRC and the client having conflicting views. An example of their interest in this subject is the recent first tier tribunal victory for HMRC where an appeal against PAYE/NIC was dismissed. This is a case which demonstrates that HMRC is looking at the entries in DLAs and that it can/will assess tax when it sees it as applicable.
The appellant company is an SME which their own accountant described at the tribunal as ‘the appellant is a small business and is conducted very informally between the shareholder directors’. (Does this ring any bells for members?)
One of the directors had loaned the company a substantial amount of money a few years ago. This was on an informal basis and so it was not clear whether there was a loan agreement or if the loan was interest bearing.
The tribunal heard that it had been ‘agreed’ that on 30 September annually his loan account was to be credited with an annual salary of £16,000. By 30 September 2013 eight such sums had been so credited. HMRC carried out an employer’s record inspection and was told that:
The tribunal heard that on 2 January 2014 the appellant’s representative confirmed that the sums credited to the DLA had been voted upon but as they had not been paid it was proposed that in the 2013 corporation tax accounts all sums credited (£128,000) would be reversed by way of prior year adjustment (PYA). That adjustment was included in the 2013 accounts and provided to HMRC on 30 June 2014.
The appellant also told the tribunal that the entries were made ‘for good housekeeping reasons, and were accrued by way of an ‘aide memoir’. It was claimed that the PYA undertaken in the 2013 annual accounts was simply to reverse out the accrual which was never really intended.
HMRC took the view that the annual sums had been accrued and any attempt to reverse the accrual by PYA or otherwise was ineffective and that the PAYE and NICs remained due. The company appealed against this.
The outcome of the tribunal was that PAYE/NIC was due on the entries and that it was not possible to avoid them by a prior year adjustment. The appeal by the company was dismissed.
Clearly the directors of this SME were not aware of the potential dangers that an ‘informal’ approach to their records might bring.
The points arising during the tribunal are very interesting and are useful to members when advising clients on similar issues:
PAYE/NIC on deemed salary: