Related party disclosure – common errors
Related parties is an area that everyone knows, but where confusion and disagreement can also occur.
The disclosure requirements in relation to related parties do cause confusion, perhaps because of the overlap between the disclosure required by the Companies Act 2006 regarding directors’ transactions and the requirements of FRS 8. There are numerous areas that can be explored, the most common being directors’ loans and dividends.
Section 413 of the Companies Act 2006 states:
‘Information about directors’ benefits: advances, credits and guarantees
(1) In the case of a company that does not prepare group accounts, details of:
(a) advances and credits granted by the company to its directors, and
(b) guarantees of any kind entered into by the company on behalf of its directors must be shown in the notes to its individual accounts.’
For parent companies preparing group accounts, the required disclosure is the same but includes advances, credits and guarantees from any subsidiaries, as well as the parent itself, to the parent’s directors.
Subsections (3) and (4) of section 413 set out the detail required in the notes to the accounts:
‘(3) The details required of an advance or credit are:
(a) its amount
(b) an indication of the interest rate
(c) its main conditions, and
(d) any amounts repaid.
(4) The details required of a guarantee are:
(a) its main terms
(b) the amount of the maximum liability that may be incurred by the company (or its subsidiary), and
(c) any amount paid and any liability incurred by the company (or its subsidiary) for the purpose of fulfilling the guarantee (including any loss incurred by reason of enforcement of the guarantee).’
This disclosure is required in respect of any person who was a director at any time in the financial year to which the accounts relate, and also for any advance, credit or guarantee subsisting at any time in the financial year, whenever it was entered into and whether or not the person concerned was a director at the time it was entered into.
What this will broadly mean in practice is that quite detailed disclosure will be required in the notes to the accounts when a company has an overdrawn director’s loan account.
FRS8 deals with related party disclosure and includes the following definition of ‘related party’:
‘A party is related to an entity if:
(a) directly, or indirectly through one or more intermediaries, the party:
(i) controls, is controlled by, or is under common control with, the entity (this includes parents, subsidiaries and fellow subsidiaries)
(ii) has an interest in the entity that gives it significant influence over the entity; or
(iii) has joint control over the entity
(b) the party is an associate (as defined in FRS9, ‘Associates and joint ventures’) of the entity
(c) the party is a joint venture in which the entity is a venturer (as defined in FRS9, ‘Associates and joint ventures’)
(d) the party is a member of the key management personnel of the entity or its parent
(e) the party is a close member of the family of any individual referred to in subparagraph (a) or (d)
(f) the party is an entity that is controlled, jointly controlled or significantly influenced by, or for which significant voting power in such entity resides with directly or indirectly, any individual referred to in (d) or (e)
(g) the party is a retirement benefit scheme for the benefit of employees of the entity, or of any entity that is a related party of the entity.’
A director is clearly a related party under that definition, so, in effect, loans to directors are caught by both the Companies Act and FRS8. That does not really matter of course, as long as the disclosure is made. But, if the entity files abbreviated accounts, the distinction becomes important because abbreviated accounts exclude FRS8 disclosures, but include the Companies Act disclosure required under section 413.
The disclosure under FRS8 should include:
(a) the names of the transacting related parties
(b) a description of the relationship between the parties
(c) a description of the transactions
(d) the amounts involved
(e) any other elements of the transactions necessary for an understanding of the financial statements
(f) the amounts due to or from related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date
(g) amounts written off in the period in respect of debts due to or from related parties.
Dividends to directors do meet the definition of related party transactions and are disclosable as such. Prior to 6 April 2007, under the Companies Act 1985, directors’ interests were disclosed in directors' reports and it was generally accepted that a reader could determine the dividends to directors on the basis of the shareholdings disclosed, and therefore there was a consensus of opinion that this was sufficient to meet the related party disclosure requirements.
Of course the other major issue with directors’ overdrawn loan accounts is taxation. If a director’s loan account, of ANY amount, is overdrawn at the year end, and not repaid within nine months of the balance sheet date, section 455 (formerly section 419) tax (at 25%) will be due to be paid by the company. In addition to this, if the loan is at no or low interest and exceeds £5000, the director should include it on his P11D, and it will be a taxable benefit in kind.