The three primary Covid support schemes

While various grants were made available at a national and local level, there were three central Covid business support schemes in the shape of the:-

• Bounce Back Loans Scheme (BBLS)
• Coronavirus Business Interruption Loan Scheme (CBILS)
• Coronavirus Large Business Interruption Loan Scheme (CLBILS)

In total, the three schemes provided £79.36 billion in loan finance with the following split:-

• BBLS accounted for the lion’s share at £47.36 billion
• The combined value of the CBILS and CLBILS facilities was £32 billion

Any scheme providing financial support at this kind of level will, in normal circumstances, be susceptible to a degree of fraudulent activity and bad debts. However, even experienced financiers have been shocked at the estimated level of fraudulent activity with the main focus on the BBLS.

CBILS, CLBILS and finally, the BBLS

Working under conditions unlikely to be seen again in our lifetime, the UK government was forced to close down the economy and began frantically working behind the scenes to launch unprecedented support schemes. On 23 March 2020, the CBILS scheme was launched, followed by the CLBILS scheme on 20 April. But, in a sign of things to come, the initial launch of these two schemes was seen as too costly, too slow and too risky.

Senior cabinet ministers, civil servants and banking executives then held 11 days of round-the-clock meetings, which culminated in the launch of the BBLS on Monday, 4 May 2020. The funds were distributed by a range of banks in the UK, with the government providing a 100% guarantee for both outstanding capital and interest. Crucially, the borrower always remained liable for the entire debt, which did not impact lending bank balance sheets.

Before the scheme closed, there had been more than 2 million applications, with 1.56 million loans approved, equating to a staggering £47.36 billion.

A fatally flawed application process

Two years after the launch of the BBLS, Lord Agnew, a joint Cabinet Office and Treasury Minister in charge of counter-fraud, stepped down. He was highly critical of the government’s “woeful” efforts to control fraud despite warnings from leading industry bodies. Later it was also revealed that the former head of the British Business Bank, tasked with overseeing the BBLS, wrote to the UK Business Secretary warning that the scheme was vulnerable to abuse by:-

• Individuals
• Organised crime gangs

In initial discussions regarding the various Covid support schemes, it is well documented that the government ordered banks to dispense with credit checks. Instead, applicants only had to confirm the following details:-

• Based in the UK
• Business trading was impacted by Covid
• Actively trading on 1 March 2020
• Solvent on 1 December 2019

The dispensing of credit checks tied in with the government’s 100% guarantee and the fact that the debt would remain with the borrower. No matter how successful or unsuccessful the schemes were, no debt liabilities would be transferred to the servicing banks.

Estimated losses through fraud

While easy to look back in hindsight and identify issues and alternative actions, the fact is that the UK government was warned at an early stage about the threat of fraud. As a consequence, HMRC initially estimated that of the £47.3 billion made available to businesses, £4.9 billion was likely to be lost due to fraudulent activity. However, this figure has since been reduced to £3.5 billion after HMRC appointed PwC to review the scheme.

While there is limited data available about BBLS losses by individual banks, we know that the biggest distributors of bounce-back loans were as follows:-

• Barclays Bank £10.9 billion
• Lloyds Bank £9.7 billion
• NatWest Group £9.3 billion
• HSBC £7.4 billion
• Santander £3.8 billion
• Virgin Money £0.97 billion

When Lord Agnew resigned, without naming individual banks, he claimed that:-

• 87% of loans paid to already dissolved companies came from just three lenders
• 81% of loans granted to companies incorporated after the pandemic originated from just two banks

Even though there has been no official confirmation of the above claims, or similar accusations, we are starting to see the emergence of several distinct patterns. However, potential losses of around £3.5 billion due to fraudulent activity with BBLS applications could be overshadowed by loan defaults (including CBILS and CLBILS). Some experts suggest this figure could be as high as £20 billion!

What constitutes BBLS fraud?

While some participants may have suggested there was a degree of uncertainty at the time BBLS funding was distributed, the criteria were unambiguous. Consequently, examples of fraudulent activity include:-

• Using funds to purchase personal assets
• Lump-sum transfers to personal bank accounts
• Distribution of funds to friends, family and third parties
• Proceeds used to fund a substantial increase in director’s salaries/dividends
• Exaggeration of turnover on application
• Company in financial difficulties before application
• Dissolving of the company to avoid repaying BBLS loan
• Multiple applications
• Creation of a new company to accommodate a fraudulent application

While there have been some high-profile prosecutions, there is much more activity behind-the-scenes.

What is the Taxpayer Protection Taskforce?

In 2021, the government announced the creation of the Taxpayer Protection Taskforce with a £100 million investment. The aim was simple; to recover as much of the billions of pounds lost via Covid support schemes as possible. 

Initially focused on the forecast £4.5 billion in fraudulent losses, the taskforce is expected to recoup just 25% or around £1.1 billion. In addition, £970 million in Covid grants have been returned to HMRC, identified as no longer required or issued in error. While funding has been made available to recruit an additional 1200 investigators, some 2300 HMRC tax compliance staff were transferred from traditional duties to Brexit and Covid-related activities. The results are, to say the least, disappointing!

The current return on investment per full-time member of the Taxpayer Protection Taskforce works out at £250,000, significantly less than the “business as usual” return of £1.3 million per person. It is also estimated that the transfer of staff has left billions of pounds of taxes uncollected. To put this into perspective, tax recovery totalled £36.9 billion in the tax year 2019/20 but just £30.7 billion in the tax year 2021/22.

Legal avenues

In addition to the Taxpayer Protection Taskforce, we have seen a significant increase in the number of HMRC investigations into BBLS-related business closures. The Serious Fraud Office has also prosecuted several directors where there has been evidence of fraudulent activity. 

If directors have participated in fraudulent activity, pursuing personal assets under proceeds of crime legislation is also possible. Even those companies legitimately closed down are receiving additional attention from HMRC, where outstanding bounce-back loans are involved.

Using cutting-edge AI technology to review BBLS claims, and gather additional information, the authorities are able to identify potential fraudulent activity much quicker.

Summary

In reality, the UK government found itself in a challenging situation with the economy grinding to a halt and businesses in dire need of rescue funding. While hindsight is a valuable tool, various parties warned the authorities that the proposed Covid support schemes were open to fraud and attracting the attention of criminal gangs.

The seemingly inefficient Taxpayer Protection Taskforce is set to close in 2023, with focus returning to more traditional investigative methods in the pursuit of outstanding Covid loans. While only a fraction of the forecast £4.5 billion in fraudulent loans is expected to be recovered, the transfer of personnel to the new task force has seen a circa £6 billion reduction in the collection of traditional taxes. While lessons will no doubt be learned, this has been an expensive exercise!

As Covid-19 began to have a considerable impact on businesses, it was evident that the UK government would need to act. One of several financial options introduced was the Bounce Back Loan Scheme (BBLS) which helped many businesses stay afloat. Fast forward to early 2022, the lifting of restrictions and companies gradually returning to a degree of normality. While the UK government was widely applauded when it made billions of pounds available to troubled businesses, there are now concerns about how the funds were used.

Details of the BBLS

Introduced on 4 May 2020, the BBLS allowed businesses to borrow between £2000 and up to 25% of their turnover. The maximum Bounce Back Loan (BBL) was £50,000, with many small to medium-sized businesses taking advantage of the financial support. The BBL terms were as follows:-

• No interest paid for the first 12 months
• No fees paid for the first 12 months
• Fixed interest rate of 2.5% a year after 12 months
• Loan duration six years

Those companies still struggling after 12 months had the option to:-

• Extend the BBL duration to 10 years
• Move to interest-only payments for a period of six months (this option can be used three times)
• Pause repayments for a period of six months (this option can be used only once)

While the loans were administered through high street banks, the government guaranteed 100% of all BBLs.

A company is a separate legal entity

Unfortunately, some company directors and shareholders do not fully understand that a company is a separate legal entity from those who control/own the business. Company funds are not directors’ funds, and they must be distributed in accordance with company legislation.

“A limited company is incorporated to form an entity with a separate legal personality, able to undertake contracts and do business in its own name.”

There may be occasions when directors must give guarantees over loans to a company. Consequently, if the company cannot make repayments, the debt must be honoured by the directors. This is no different to an individual guaranteeing a loan for another individual, both legal entities in their own right.

Misuse of company funds

Lord Agnew, the minister in charge of Whitehall efficiency, recently resigned from the UK government over its handling of fraudulent BBLS claims. This is becoming a serious problem for the government. In January 2022, it was confirmed that the Treasury expects to write off £4.3 billion of the £5.8 billion of public money fraudulently claimed by businesses. This is money identified as having been obtained fraudulently, but the government has no real hope of retrieving it. Furthermore, it appears that some BBLS applications came from companies that weren’t even trading at the time!

This brings us to the misuse of company funds, and the potential consequences directors face under Companies Act legislation.

Example of misuse of company funds

Many accountants and clients up and down the country will be having similar conversations to this:-

Client: I just had a house extension and a new kitchen.
Accountant: How much did that cost?
Client: £50,000
Accountant: How did you pay for that?
Client: Bounce Back Loan
Accountant: But wasn’t that a loan to your limited company?
Client: Sigh. It’s my company, so it’s my money.

So what are the repercussions of this type of scenario?

Legitimate ways to withdraw funds from your company

There are four legitimate ways in which you can withdraw funds from a company, to your personal account:-

• Salary
• Dividend payments
• Reimbursement of expenses
• Directors loan

It is essential to the aware of the logistics when withdrawing funds from your company. You don’t want any unwelcome surprises!

Salary

Most company directors will pay themselves a relatively low salary, enough to qualify for state benefits, often without income tax or national insurance liabilities. This is a perfectly legal and tax-efficient way of withdrawing money from a company.

Dividend payments

Many directors pay themselves a salary with a significant element of their income paid via dividends, paid from distributable reserves. These are funds accumulated over the years from post-tax profits – if there are no distributable reserves, no dividends can be paid.

Reimbursement of expenses

If a director incurs an expense directly related to the business, this can be reclaimed from the company with supporting documentation. This would traditionally take in the likes of client entertainment, use of home, staff entertainment, telephone calls and business mileage. If HMRC was to question any of your expenses, it is crucial you have the supporting documentation to hand.

Director’s loans

A director’s loan account reflects the net balance of:-

• Funds due to a director from the company
• Funds due to the company from a director

It is perfectly legitimate for a company to lend money to a director, or vice versa, although there are strict regulations about interest charges and repayment.

Potential repercussions of failing to repay company loans

Unfortunately, as we touched on above, some company directors have used BBLS money to shore up their personal finances. Those who treat company funds as “their own” could be in for a costly shock!

In the above example, let us assume that the director withdrew £50,000 (over and above salary payments) during the company financial year 1 April 2020 to 31 March 2021. On 31 March 2021, the company had distributable reserves of £10,000, from which a dividend was paid. The situation would be as follows:-

Director’s loan: £50,000
Dividend: £10,000

Rather than take receipt of the £10,000 dividend payment, this would be offset against the £50,000 debit on the director’s loan account. Leaving a net debt of £40,000 that would need to be repaid at some point.

Benefit in kind

In certain circumstances, the debit on a director’s loan account is considered a benefit in kind and therefore taxable. The conditions are as follows:-

• The loan amount is £10,000 or more
• No interest is being paid on the loan OR
• Interest being paid falls below the HMRC average official rates

If these conditions are met, then you will need to record the loan on a P11D form and as part of your self-assessment tax return. As a director, you may be liable to personal taxes on the loan amount, depending on your financial situation. The company may also be liable for national insurance contributions on the loan amount at a rate of 13.8%.

Personal tax: Outstanding loan amount would be added to your annual income and taxed accordingly
National insurance contributions: 13.8% x £40,000 = £5520 (paid by company, non-refundable)

If you have an arrangement whereby you pay a commercial rate of interest on the balance of your director’s loan account, this would not be classed as a benefit in kind. Consequently, it wouldn’t be part of your self-assessment tax return.

Corporation tax

As far as repercussions for the company, if the outstanding director’s loan is repaid within nine months and one day of the company’s year-end, there is no additional tax liability. However, if the loan is not repaid in full, in the above example, before 1 January 2022, the company would be charged corporation tax at 32.5% on the outstanding balance. This is referred to as S455 tax, and while it is refundable once the director’s loan has been repaid, it may take some time to receive repayment from HMRC.

Additional corporation tax: 32.5% x £40,000 = £13,000 (refundable on repayment of loan)

Liquidating a company to avoid BBLS liability

There is some confusion about whether you can liquidate a struggling company with a BBLS liability. The simple answer is yes, but there may be consequences depending on the scenario:-

BBL used for the benefit of the company

If BBLS funds were used wholly for the company’s benefit, but the company still failed, entering administration or liquidation, this is perfectly legitimate. In this scenario, directors would have no personal liability towards the outstanding BBL. As an unsecured loan, the banks would usually be treated the same as any other creditor. However, as the UK government guaranteed the BBLS, this would protect banks from any losses.

BBL is not used per the terms

The terms of the BBLS dictate that the funds received from the UK government are used for the company’s benefit. However, if a company entered administration/liquidation with evidence that BBL funds had been misused, this is a very different scenario. If misuse was proven, then the company’s directors could be made personally libel for repayment of the outstanding balance.

Summary

As a director, it is essential to be aware of legitimate ways to withdraw funds from a company. If any withdrawn funds are not classified as salary, dividends or expenses, they will be debited to your director’s loan account. As covered above, there are clear regulations governing the use of director’s loan accounts and the repayment of outstanding balances. This issue is sure to come to the fore in years to come, with concerns that some directors have used BBLS funding for non-company activities.

Sources:-

https://inews.co.uk/news/politics/treasury-minister-lord-agnew-quits-over-government-handling-of-covid-loan-fraud-1420306

https://www.ukliquidators.org.uk/company-debt-advice/what-is-deemed-misuse-of-a-bounce-back-loan

https://www.gov.uk/government/news/insolvency-service-cracks-down-on-bounce-back-loan-abusers

https://www.gov.uk/guidance/apply-for-a-coronavirus-bounce-back-loan

https://www.gov.uk/government/news/new-bounce-back-loans-to-launch-today

https://nixonwilliams.com/free-resources/limited-company/how-take-money-limited-company

https://nicholsonandco.co.uk/as-a-director-what-should-i-pay-myself-in-2021-22/

https://www.accaglobal.com/uk/en/technical-activities/uk-tech/in-practice/2021/may/10-things-directors-loan-account.html

https://www.goforma.com/small-business-accounting/what-is-directors-loan-account