Don't board directors' loan gravy train

IMAGINE being able to borrow from a bank where the interest rate is zero and you pay the money back when you like. Sounds like a dream doesn't it?

Unfortunately, this is how many directors treat money they use or borrow from their own company. If not handled carefully the dream can turn into a nightmare!

It is fine for a director to lend money to the company but borrowing from the firm is actually in contravention of Section 330(2) of the Companies Act 1985.

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There are exceptions to this general prohibition: loans under 5000 made to a director and advances up to 20,000, where the purpose is to enable the director to meet any expenditure to perform his duties or to meet expenditure for company purposes, are permissible subject to prior approval at an annual general meeting of the company.

Section 342 of the Act provides that if a director knowingly permits the company to make an illegal loan he is guilty of an offence and is liable on indictment to up to two years in jail and/or an unlimited fine!

In principle, some directors think that taking loans is a good idea because if your business is cash rich why go to the bank and pay interest when you could borrow what is effectively your own money? However, in addition to the Companies Act requirements there are strict tax rules governing directors' loans and HM Revenue and Customs is taking a dim view of those who try to bypass these regulations.

Timing of taking a loan is crucial. Loans must be repaid within nine months of the company's financial year end to avoid the taxman charging the company 25 per cent of the loan outstanding under Section 419 of the Taxes Act. The amount levied under 419 would eventually be repayable to the company after the loan had been repaid to the company by the director. In addition to a possible charge under 419, the company has an obligation to declare the beneficial loan interest (the notional interest payable) as a benefit in kind and the director must then self-assess this on their own tax return.

Revenue and Customs will look closely at any overdrawn directors' loans as a lucrative source for possible under-declared tax. The best policy is therefore to try to pay back the loan as quickly as possible.

In many small family companies the line between company and family funds can frequently become blurred. This is particularly dangerous in terms of directors' loans.

Any hint that loans are being used as a means to avoid PAYE will incur the wrath of Revenue and Customs.

Only borrow from the company if you really have to - and seek advice first from your professional adviser.

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George Primrose, managing partner, Condies,

Condies, one of Scotland's leading firms of chartered accountants and business advisers, is providing a series of articles offering practical advice to SMEs