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Another Overdrawn Director's Loan Account Question

Should I make Prior Year Adjustments to reinstate an Overdrawn Directors Loan Account?

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I have taken on a new client who is a family friend. A one-man-band limited co that makes around £75k a year before owner/director take of salary/dividends. All profits are usually taken out each year.

In last financial year Co borrowed £100k from a P2P lender. Director withdrew around £80k of this for personal use having also drawn out all distributable profits for the year. This extra £80k couldn't be covered by distributable profits so previous accountant cleared the overdrawn DLA at year-end as follows:

  1. £30K taken as dividends in excess of available reserves.
    • Before declaring these dividends, the previous accountant noted in writing that these were in excess of available profits.
  2. Director “assumed liability” for £50k of the P2P borrowings.
    • This was done solely via a Management Rep Letter point to this effect.
    • No formal assignment of this £50k of debt from P2P to Director was undertaken (although Director has given personal guarantee).
    • Entry in accounts was therefore to debit P2P borrowings £50k and credit DLA £50k.
    • Genius.

Director was entirely unaware of the problems this has caused but is willing to repay the £80k above by personally borrowing the money from family.

My questions are:

  1. To me the adjustment at 2. above is clearly wrong.  £50k of the Company liability to the P2P lender can’t be derecognised by the Director simply “assuming it”. Anyone disagree?
  2. Whilst drawing dividends in excess of distributable reserves does not automatically make them “illegal dividends”, I think these are probably illegal as the accounts drawn up to justify them showed them to be in excess of reserves. Does anyone disagree?
  3. Although I usually try and avoid making Prior Year Adjustments to correct a previous accountants’ mistakes, I don’t think I can avoid doing this here as the £50k is clearly material (total liabilities are £124k at present). Anyone not agree?
  4. Can I also "undeclare" £30k of dividends via a PYA?

Obviously, correcting all of this will require a refiled CT return (to recognise the S455 issue) and personal tax return (to remove £30k of dividends), plus interest on unpaid CT until the DLA/S455 is cleared, BIK  tax/NIC issues on overdrawn DLA plus god know what.

Am I overthinking all this or am I correct to just bite the bullet, make PYAs and refile everything? My problem really stems from Q1) above, in that I am not willing to prepare accounts for the current year that, in my opinion, understate the Company liabilities by £50k.

Any help or suggestions would be much appreciated.

Replies (11)

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By Wanderer
11th Jan 2020 16:33

ChrisKM wrote:

Genius.

Stunning!
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RLI
By lionofludesch
11th Jan 2020 17:28

These dividends aren't illegal. They're unlawful (probably). They are liable to be repaid if some creditor or court comes along and demands it. Until that happens, they stand for me.

I'd probably resubmit the accounts to Companies House. But you definitely ought to submit the CT600 showing the loan to the director.

The fact that the director is clearing his loan is a plus for me. Matters put right, albeit belatedly.

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Replying to lionofludesch:
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By legerman
12th Jan 2020 09:12

lionofludesch wrote:

These dividends aren't illegal. They're unlawful (probably). They are liable to be repaid if some creditor or court comes along and demands it. Until that happens, they stand for me.

Just thinking aloud for my own knowledge. OP said there were no reserves to cover this so am I right in thinking the accounts would show reserves -£30k which gives £30k less to distribute the following year (on paper)? Would it be ok in that scenario to take the distributable reserves for this year and retain the
-£30k balance?

I'm also wondering why the specific split. could the Director have taken 80k (1) as divs for instance and if not why is 30k acceptable?

(1) Point noted they would be unlawful, but so would £30k

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Replying to legerman:
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By JoF
12th Jan 2020 10:00

Would suggest re your scenario that it's not advisable, especially if the company is relying on credit from suppliers, bank or other funding.

Re the amount, I'm assuming it's related to personal tax position of the director.

Out of interest, Chris, what view has the P2P taken of the director nabbing the funds for himself?

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Replying to JoF:
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By lionofludesch
12th Jan 2020 10:15

JoF wrote:

Out of interest, Chris, what view has the P2P taken of the director nabbing the funds for himself?

Oh - you think the lender knows ?

That never occurred to me.

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Replying to lionofludesch:
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By JoF
12th Jan 2020 10:32

lionofludesch wrote:

Oh - you think the lender knows ?

Highly doubtful tbh.

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Replying to legerman:
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By lionofludesch
12th Jan 2020 10:05

legerman wrote:

I'm also wondering why the specific split. could the Director have taken 80k (1) as divs for instance and if not why is 30k acceptable?

(1) Point noted they would be unlawful, but so would £30k

Acceptable is probably the wrong word.

The director took £80k.

A dividend was declared for £30k.

Ergo, the dividend is £30k. Albeit unlawfully -unless there were sufficient profits by the time it was declared, which we don't know.

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By ChrisKM
12th Jan 2020 12:06

Many thanks for all the responses.

The lender is unaware of the £50k “issue”. The initial borrowing applied for was £20k to fund legitimate new equipment for the business. When the P2P saw the accounts, projections, etc they immediately offered £100k; this is a successful and profitable business. Director knew he had personal tax, etc to pay so, without thinking, just went for it.

With regards to the £30k / £50k split, the previous accountant initially had it all as dividends in the draft accounts and then suggested the £50k adjustment.

With regards to the “unlawful” dividends, they were unlawful I believe as they were based on draft accounts showing huge negative reserves and were pointed out in writing to the Director. I wanted to reverse them as part of the Prior Year Adjustment because i) I am worried that HMRC could attack these as salary rather than dividends, plus ii) as he is still in time to refile last years pesonal tax return we could get the tax back he paid on these. I realise ,though, that this would raise even further alarms with HMRC.

It does sound like the best way to go is:
• PYA or refiled accounts for the £50k.
• Refile CT return with DLA overdrawn.
• Keep the £30k dividends as they were declared.
• Director borrows money to repay the £50k DLA.
• Director takes reduced drawings/dividends going forwards to enable the negative reserves to be eliminated.

Any other suggestions and comments would be very welcome.

[And you don’t even want to know what has happened with MTD and VAT when the Director took over doing the VAT returns and used Xero to file them, but I will give you an example - he treated some of his "drawings" as salary inclusive of 20% VAT, which he then claimed back in the VAT returns - Happy Days].

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Replying to ChrisKM:
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By lionofludesch
12th Jan 2020 12:21

ChrisKM wrote:

With regards to the “unlawful” dividends, they were unlawful I believe as they were based on draft accounts showing huge negative reserves and were pointed out in writing to the Director.

A hugely profitable business with huge negative reserves ?

Quote:

[And you don’t even want to know what has happened with MTD and VAT when the Director took over doing the VAT returns and used Xero to file them, but I will give you an example - he treated some of his "drawings" as salary inclusive of 20% VAT, which he then claimed back in the VAT returns - Happy Days].

Mistakes are impossible under MTD.

So we were told.

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Replying to ChrisKM:
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By petestar1969
15th Jan 2020 10:25

He may be a friend, but do you really want to act for him?

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By James99001
15th Jan 2020 13:26

Where the dividend is known to be unlawful by the recipient, HMRC's manuals note that the dividend has not been properly declared and accordingly should be taxed as a loan (where s455 applies etc.)

https://www.gov.uk/hmrc-internal-manuals/company-taxation-manual/ctm15205

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