Contractors’ Questions: How to clear an overdrawn loan account?

Contractor’s Question: As joint-partners of our IT company, we have always turned down a full salary in favour of taking out money every quarter and declaring a dividend every so often. But in the last 12 months, it appears that we have taken out more than the declared dividends. As this has created loan accounts owing to the company, must we now make a repayment and how?

Expert’s Answer: In the event that you have fallen behind with your dividends and now have an overdrawn loan account, you mainly have three options.

Firstly, assuming that the company has sufficient profits, you could clear your loans by taking a new dividend.

As an alternative way to clear the account, take the net pay you would get by putting through additional salaries, paying PAYE and national insurance.

Thirdly, the most straightforward way – simply repay the cash into the company.

Look at your personal finances to determine which of these three options is the most appropriate for you. As to the third option, if you can stump up the personal funds, this wouldn’t give rise to a tax liability.

But if you cannot repay the loan personally, the dividend option will be the next most tax-efficient route, but it can be made only from historic profits.

And if the overdrawn account exceeds £10,000 during the year, it will be classed as a beneficial loan unless the company charges you interest. The rate of interest needs to be at least 3% - HMRC’s current official rate – to save you having to include it on form P11D.

Lastly, be aware that your company may incur a corporation tax charge if any loans are not repaid. A 25% tax charges arises on the balance outstanding nine months after the year-end, although fortunately this is repayable by HMRC when the loan is repaid.

The expert was Jon Dawson, tax partner at Kingston Smith LLP.