Director’s loan and Section 455 charge
If a director owns money for his company and that loan is outstanding 9 months and 1 day after the end of the accounting period in which it was made (the date that the corporation tax for the period is due), then the company must pay Section 455 tax charge of 32.5% on the overdrawn balance.
How to avoid Section 455 tax charge and what are anti-avoidance rules
Your Section 455 tax charge can be avoided if you pay your loan before the corporation tax due day. However, you need to be aware of anti-avoidance rules. These rules are set to ensure that all repayments are genuine repayments, and not transactions designed to avoid the Section 455 tax charge.
- Rule 1: The 30-day rule
The 30-day rule applies when within 30 days of loan repayment bigger than £5,000, the director borrows from the company again. The rule effectively renders the repayment in-effective up to the level of the funds that are re-borrowed. Section 455 tax is payable on the lesser of the amount of the loan repaid and the amount re-borrowed. The 30-day rule applies despite which transaction happened first – loan repayment or further borrowing. This rule prevents directors from taking a new loan and using it to repay the original one/part of it.
- Rule 2: The intentions and arrangements rule
When the 30-day rule does not apply because the period between repayment and taking a new loan is more than 30 days, the intentions and arrangements rule comes to play to help to deal with tax avoidance.
This rule applies when the balance of the loan outstanding before the repayment is at least £15,000 and, at the time a loan repayment is made, there are arrangements, or an intention, to subsequently borrow £5,000 or more. It also applies outside 30 days period, meaning that the rule will be applicable if the repayment is made with the intention to redraw at least £5,000, irrespective of when this is done.
However, the rule does not apply to funds extracted by way of a dividend, salary or bonus, as these are within the charge to income tax.
Clearing an outstanding loan to avoid Section 455 charge will only be tax-effective if done either by a dividend, bonus or salary payment (which have tax charges on their own) or by using funds from outside the company to be considered as a genuine repayment.
It is very common for directors to borrow money from or lend money to their company, especially if the business is at an early stage and belongs to their family. Those transactions are recorded in a director’s loan account. To find out more about the Director’s loan, please visit the official government website.