Directors Loan - Correct Entries

Kimozaki

Hello everyone

This is my first post on the forum so I hope that I've posted it in the right place. This may be a tad long winded so please bear with me as I want to give as much detail as I can in hope that somebody can assist me.

A family member purchased a garage business for £33k which was paid directly into the seller's personal bank account.

The seller's accountant advised the seller that it would be best to split this as £18k as the purchase price of the business and then £15k as the repayment of the seller's Directors Loan. This meaning that my family member had then provided a new directors loan of £15k. The accountant advised that this would save on complicated draw down agreements and that my family member would then be able recoup the £15k Directors Loan from the business without any tax implications.

The seller's Directors Loan was actually showing in Sage Instant Accounts as £9,758.06.

The seller also paid back £3,802.99 into the business bank account to cover the solicitor and consultancy fees relating to sale of the business of which there was not enough money in the bank to cover.

As none of the above went through the company bank account, except for the £3,802.99, I'm not sure of what entries to make to deal with this correctly in the accounts? I currently have £3,802.99 sat in the suspense account as I do not know what to treat this as either.

Any help or advice much appreciated.

Many thanks

Kim

CeeJaySix

Kim,

I assume this is a sale of a limited company (as there's a director's loan)?

Has your family member purchased the share capital from the old director, or the trade and assets of the business from the business itself?

Are there any other shareholders?

Kimozaki

CeeJaySix

Thank you for your reply.

Yes, that's correct the company purchased is a private limited company.

The share capital was purchased from the previous director so as to acquire the company as a whole and the payment was made into the seller's own bank account rather than into the company's bank account.

My family member is the sole shareholder owning 100% of the shares at present.

CeeJaySix

This isn't a transaction with the company, it's a sale between two individuals, hence payment into private account. The only accounting entries would be regarding the director's loan.

My feeling is the the professional fees belong to the individual rather than the company as he is selling the shares, not the company; they may well be allowable as a deduction from the sale proceeds in his capital gains computation, but that's by the by here as we're talking about the buyer and the company.

Therefore the credit that you have in suspense should be set against the nominal code to which those professional fees were first posted to remove the expense from the company accounts; essentially the company has incurred an expense on behalf of the director, and the director has then repaid it.

That leaves the DLA balance. There can be no argument about the balance, it cannot be both £15k and £9,758. The first thing to do is ensure Sage contains the correct balance - check the bank reconciles, and that there's no other cheeky credit owed to the director floating around in other creditors; sometimes the petty cash nominal is used to hold the director's out-of-pocket expenses. Confirm this with the outgoing director.

Once you have established the actual loan amount and got it all into the correct nominal, you're done from a Sage perspective; your family member is owed that much money by the business.

However for future (individual) capital gains purposes, you will need some record of the consideration paid for the shares. This will be the £33,000 less the value of the director's loan account. I don't know the legal ins and outs of this, but as a minimum I'd want a document signed by both parties acknowledging this value as the sale price, and that the debt owed by the company to the outgoing director (along with its value) has been transferred to your family member. I'm sure someone here with more experience can advise further, or seek legal advice.

Essentially your family member has paid X for the rights to the director's loan debt, where X is the current monetary value of that debt; the remainder of the £33k is then the price he has paid for the shares.

As ever I stand by to be corrected, but that's my take on it.

Gem7321

I agree mostly with the above, and I'm definitely no expert, but I don't think the consideration for the shares will be £33k less the directors loan. The share price is the share price and this needs to be determined. Then any excess is an extension to the existing directors loan which the new director has now acquired. Let's say that the consideration for the shares is determined to be £18,000 then the new directors loan is £15,000 on top of the already existing directors loan.

Like I say I'm no expert so I don't know if this is correct. Don't concern yourself too much with the sellers affairs, it's up to his accountant to sort out if he has taken a distribution/consideration above the value of his directors loan.

KernowAccountant

Gem7321 said:

I agree mostly with the above, and I'm definitely no expert, but I don't think the consideration for the shares will be £33k less the directors loan. The share price is the share price and this needs to be determined. Then any excess is an extension to the existing directors loan which the new director has now acquired. Let's say that the consideration for the shares is determined to be £18,000 then the new directors loan is £15,000 on top of the already existing directors loan.

Like I say I'm no expert so I don't know if this is correct. Don't concern yourself too much with the sellers affairs, it's up to his accountant to sort out if he has taken a distribution/consideration above the value of his directors loan.

I haven't read CeeJaySix's reply in depth, but I'm struggling conceptually with your proposal that the DLA can be increased by £15,000 when that cash has not physically made it into the Company's bank account - it hasn't been loaned to the Company, it's gone to the former shareholder.

I could of course be missing the point!

CeeJaySix

Gem,

Sorry, I may be being a bit dense but I can't see your point. As this is a purchase of shares from one individual by another, the consideration is the consideration? The only complication is that the DLA creditor needs to be transferred from one individual to another; essentially director A (outgoing) is repaid by the company, director B (incoming) pays A £33k less DLA amount for the shares, B then loans company the DLA amount.

Net effect: A gets £33k less DLA in consideration, plus DLA from company. B pays A £33k less DLA for shares, loans company DLA, and company recognises no movement in DLA creditor.

Okay the transactions haven't gone through the company account in respect of the repayment and re-loaning of the DLA, but the end-state is the same?

Kimozaki

Thank you for all of your replies, your help is much appreciated.

I'm certainly no expert, this is all entirely new for me, but the replies from CeeJay and Kernow make the most logical sense in my mind. The DLA cannot be increased by £15,000 as the money never entered the company account - that I do know. It was confusing me as to how I could increase the DLA from £9,758 to £15,000 but now I know that the DLA has to be the balance shown in Sage. I will also look through the Petty Cash nominal as I am well aware that a lot of the previous Director's out of pocket expenses have been posted there.

I think part of the problem is that the seller didn't quite paint the whole picture for his accountant when they provided advise to him considering that £15,000 wasn't the existing value of the DLA.

Gem7321

But it has already been stated that the sale of the shares is £18k. Any difference between the £33k paid and the DLA and the share price, I think, should be treated as a distribution which effectively the new director has paid on behalf of the company and therefore increasing his DLA.

But like I say, I'm no expert! Think you need to speak to the sellers accountant to get this resolved and consider some legal advice.

CeeJaySix

Ah, I see where you're coming from Gem, having re-read the OP I see that it could be read as the consideration was agreed at £18k.

The way I understood it was that the old accountant had said to treat the remainder of the total proceeds after repaying the DLA as the proceeds of the share sale, and this amount was £18k because he thought the DLA was £15k when it was in fact lower.

I agree it can be read both ways. If you are correct I agree, and the only journal required would be to dr dividends paid, cr DLA, for £5,242 to bring the DLA up to £15k. Clearly the business would need to have sufficient reserves to pay the dividend.

Then effectively the new owner has paid £18k for the shares, and £15k for the DLA, as the outgoing accountant suggests. Makes no real difference in the short term, but ultimately the cost of the shares are lower and therefore he will have more capital gains to pay later; however he will be able to extract more cash from the business without paying tax on dividends as the DLA is higher. Best approach could be argued every which way, depends on whether higher rate taxpayer, availability of ER on future share sale, etc etc.

Outgoing owner will obviously need to declare the extra dividend on his self assessment.

Kimozaki

I'm not entirely sure where the £15k DLA came from, it can only have come from information provided by the outgoing director or the director's wife who was acting as bookkeeper for the business. So it is my assumption that they advised the split of the £33k how they have based on what they were told.

Unfortunately the business did not/does not have sufficient reserves or any for that matter to be able to pay a dividend. Would this be why the outgoing accountant has advised as they have, so that the outgoing director could extract his DLA from the business? If the shares had been purchased for the full amount paid of £33k then would the buyer have also purchased the rights to the DLA shown in Sage anyway?

KernowAccountant

I struggle to see that the difference between the DLA balance recorded in the company's books and the £15,000 amounts to as a distribution as defined by s.1000 CTA 2010. Note how s.1000 refers to "by the company" and "out of the assets of the company" i.e. the company is the originator of the transaction.

The outgoing director had an asset: the loan to a company - this was sold for greater than its face value (i.e. £15,000 rather than £9,758). The price of the shares is still £18k.

This is no different to, say, a gilt being traded above its par value.

The OP indicates that the £15k payment was made to the vendor in their capacity as director (not shareholder, which would surely be a prerequisite for a distribution) and hence I contend that the payment is not a distribution.

CeeJaySix

I see your point, but why overpay for a director's loan? It's not going to appreciate in value, I'd rather be paying more for the shares to save on capital gains later (clearly it's not up to the buyer to pick and choose after the event, but we don't know what the arrangement is here).

If the company has no distributable reserves then that rules out the option of the DLA being 'topped up' by declaring a dividend.

The OP indicates that the £15k loan repayment could be drawn by the incoming director with no tax consequences. This does not appear to be the case if the loan he has purchased is only £9k.

I think in the absence of any paperwork evidencing the terms of the sale you will need to go back to the outgoing director and/or accountant to find out exactly what has gone on; apart from anything else it will affect your incoming director's tax position both on his drawings from the company and on sale of the shares, so it needs to be established with some kind of certainty.

Kimozaki

As there appears to be no definitive answer I've sent an email to the previous accountant to establish exactly what has occurred.

Thank you everyone for taking the time to provide help and advice.

Kimozaki

I've now obtained a copy of the Share Sale Agreement which states:

'The consideration for the sale of the shares shall be the sum of £33k of which £15k was to be paid as a loan amount to the business for the purpose of repaying the DLA to the outgoing director and meeting the associated costs of the sale of the business, payable in cash on Completion to the Seller'.

This might make things a little clearer with this information. Can anybody advise further please on what entries are to be made in the accounts?

CeeJaySix

I'm still of the opinion that there are no 'associated costs of sale to the business' - as the sale was of shares, the costs of sale belong to the holder and his personal tax comp, and any expenses incurred in the sale would fail the wholly and exclusively test. Therefore the credit on suspense should still go back against wherever the expenses were posted, and that part of the clause above is meaningless.

If you think the costs are allowable in the business, the credit can go against the DLA, which would be tax advantageous for both the company's CT and the new owner's drawings (more DLA available to draw before dividends required). You would need to make sure you can justify the costs of sale as being allowable.

It sounds to me on the above wording like KernowAccountant's initial thoughts were correct, and the new director has paid greater than the monetary value for the DLA. No accounting entries required, he's simply out of pocket; on the bright side there will be no tax on the £9k-odd when he draws it, which will claw back some of the personal difference.

His cost for future disposal will be the £15k.

Anyone see it differently?

KernowAccountant

CeeJaySix said:

I'm still of the opinion that there are no 'associated costs of sale to the business' - as the sale was of shares, the costs of sale belong to the holder and his personal tax comp, and any expenses incurred in the sale would fail the wholly and exclusively test. Therefore the credit on suspense should still go back against wherever the expenses were posted, and that part of the clause above is meaningless.

If you think the costs are allowable in the business, the credit can go against the DLA, which would be tax advantageous for both the company's CT and the new owner's drawings (more DLA available to draw before dividends required). You would need to make sure you can justify the costs of sale as being allowable.

It sounds to me on the above wording like KernowAccountant's initial thoughts were correct, and the new director has paid greater than the monetary value for the DLA. No accounting entries required, he's simply out of pocket; on the bright side there will be no tax on the £9k-odd when he draws it, which will claw back some of the personal difference.

His cost for future disposal will be the £15k.

Anyone see it differently?

Agreed. I cannot see any scope for relief for the costs of sale in the company - as you say, they're attributable to the shareholder.

They may, of course, be considered incidental costs of the acquisition of the shares and hence capital gains tax relief should be due for the new shareholder should he dispose of the shares.

CeeJaySix

Sorry, his cost for future disposal would be the £18k, typo on my part.

I read the costs as having been incurred on the sale rather than the purchase, and therefore deductible from the proceeds for the seller's CGT, but I think we've pretty much done this to death now!

Kimozaki

I agree Cee-JaySix it's pretty much been done to death.

Thank you all for your replies and help. It's all straight in my head now!