A recent High Court case has raised serious concerns for individuals who use company money for personal expenses via their director’s loan accounts.
We have previously written about the consequences of directors or shareholders borrowing money from a private company here – as mentioned in that article, such arrangements are very common for private, unlisted companies. There are various tax consequences of borrowing money from these companies but, although onerous, these are generally manageable.
The scale can vary significantly – from perhaps one or two private expenses put through the company (maybe even by accident) and then repaid later, to a much wider use of company money on an almost daily basis, often cleared by dividend on an annual basis.
However a recent case (McCarthy v Marshall) in the High Court (although not specifically a tax case) has brought the latter into sharp focus – in essence ruling that “company money is not a personal cash machine”.
In the particular case, the company concerned had been liquidated and a case was brought by one former shareholder against another relating (amongst other things) to the manner in which the latter had used company money for his personal lifestyle. The court agreed with the case made against that shareholder, ruling that his use of company money was unauthorised and amounted to a breach of fiduciary duty, even if he always intended to repay the money.
Crucially, the court decided that this unauthorised use of company money for personal purposes amounted to “such reckless indifference to the company’s interests that the breach was fraudulent”. The reasoning for this is that such borrowing can negatively affect the company through reduced liquidity, higher costs of borrowing or reduced ability to profit from its trading activities.
This case should therefore be a significant wake up call for directors and shareholders of businesses where company money is habitually used for personal expenses, even if there is a routine and process for repaying that money regularly.
Although we will need to see how things develop in the coming weeks, in practice it only appears likely to be a problem in a case of a dispute or insolvency, meaning that single shareholder companies might be ok. However even a husband/wife company may have a future problem if there is a divorce, for example.
Our advice to clients is always that company funds should not be used in this way. However where this practice does exist, those involved can protect themselves by ensuring that such use of company funds is fully authorised by all shareholders with supporting board minutes.
Looking forward, it is also likely that in a company sale scenario the lawyers acting for the buyers might be looking for evidence that any director/shareholder borrowings have been properly authorised, making it even more important to maintain that evidence where there is an exit plan in place.
But by far the most concerning point here is the decision that such use of funds might constitute fraud, raising a very real (however remote) possibility of a criminal offence coming into play.
Contact James Geary for more information by emailing james.geary@randall-payne.co.uk or calling 01242 776000.
Why does the £10,000 threshold matter for a Director’s Loan?