Director’s loan account and the best order of repayments
In the early stages of a business, the company’s director may often borrow money from its company, especially in family businesses. This is an easy source of finance that can also be tax-efficient if timed correctly. Directors can borrow up to £10,000 for up to 21 months tax-free. Find out more on how to record your personal expenses in our previous blog.
Despite that, there might be some tax consequences if the Director’s loan remains outstanding for 9 months and 1 day after the end of the accounting period. This date is when the corporation tax is due for the period and the company will have to pay ‘Section 455’ tax on the outstanding director’s loan balance.
Section 455 tax rate increase
Section 455 tax is aligned with the dividend upper rate. Between 6 April 2016 and 5 April 2022 the rate was 32.5%, and before that – 25%.
After the recent government announcement of a new Health and Social Care Levy, the dividend tax rates increased by 1.25% from 6 April 2022. Due to this reason, the Section 455 rate rose to 33.75%.
Reclaim Corporation Tax
Section 455 tax differs from other forms of tax. It is a temporary tax that is repaid after the outstanding loan has been cleared. The claim can be issued after 9 months and 1 day after the end of the accounting period when the loan was repaid. It must be claimed within 4 or 6 years, depending on the time when the loan was repaid. Find out more about how to reclaim it on the government’s website.
The order of loans repayment
Companies can repay this loan in various ways including introducing funds from outside the company, declaring a dividend or setting a bonus or salary payment against this loan.
In case the director has several outstanding loans, then loans that have a higher Section 455 tax rate should be paid first.
The best order to repay your Directors loan:
- Loans made on or after 6 April 2022 (tax rate is 33.75%).
- Loans made between 6 April 2016 and 5 April 2022 (tax rate is 32.5%).
- Loans made before 6 April 2016 (tax rate is 25%).
Example of loans repayment
James is a director of James & Sons Ltd. He prepares his accounts by 30 April each year.
He took a loan of £20,000 from James & Sons Ltd in July 2015. His company paid £5,000 of Section 455 tax on 1 February 2016 (25% tax rate of the total loan amount).
James then took a further loan from James & Sons Ltd of £15,000 in May 2018. The company paid £4,875 Section 455 tax on 1 February 2020 (32.5% tax rate of the total loan amount).
Currently, James is planning to do some extra work in April 2022 and take a further loan of £25,000 on 20 April 2022. He needs to clear his loan by 1 February 2023, otherwise, James & Sons Ltd will have to pay £8,437.50 of Section 455 tax (due to the recent tax increase to 33.75%).
James has an endowment policy that will mature in August 2022, the proceeds of which are £50,000 and plans to use it to clear his loans. To make sure he uses this money in the most effective manner to secure the maximum tax savings/repayments, he needs to clear his loans in the following order:
- Loan of £25,000 which was taken in April 2022. Clearing this loan first will save James&Sons Ltd £8,437.50.
- Loan of £15,000 which was taken in May 2018. Clearing this loan will generate a repayment of £4,875 on 1 February 2023.
- £10,000 of the £20,000 loan, taken back in July 2015. This will generate a repayment of £2,500 on 1 February 2023.
Paying in this order will save tax and generate several repayments of a total of £15,812.50.
If James had cleared his loans in chronological order, his repayment of the 2015 loan would be £5,000 and £4,875 for his 2018 loan. He could only clear £15,000 of his 2022 loan (saving Section 455 tax of £5,062.50). The total tax savings and repayment would be £14,937.50 and he would also need to pay Section 455 tax of £3,375 on 1 February 2023 (against which the repayment due to him of £9,475 could be set).