Loans to directors & section 455 charge
Directors and shareholders in close companies (which are controlled by five or fewer shareholders) are able to influence the payments that are made to them. Personal and most family-run companies are usually considered close.
Close companies often have numerous transactions between the director and the company. Those transactions include payments to the director, loans to the director or payments on the director’s behalf. The director may also loan money to the company, repay loans or make payments on the company’s behalf.
The director’s loan account helps to keep track of the transactions between the director and the company. However, tax consequences arise if the director’s loan account is overdrawn at the end of the accounting period or if a loan has been made which has not been repaid.
If a loan is repaid by the corporation tax deadline
The corporation tax for an accounting period is due for payment 9 months and 1 day after the end of the accounting period. If the loan is repaid in this period or the overdrawn balance is cleared, there are no further tax consequences.
However, the loan must be reported on the company’s corporation tax return. If the amount owed by the director to the company exceeds £10,000 at any point in the tax year, there may also be a benefit in kind tax charge for the director, and a Class 1A National Insurance liability on the company.
An overdrawn account can be cleared in several ways such as paying money into the company from personal resources, crediting a bonus or salary payment to the account, or by declaring a dividend. Note that there will be tax and National Insurance contributions on a salary or bonus payment and tax on a dividend.
If a loan remains outstanding
If the loan hasn’t been repaid and the director’s account remains overdrawn at the corporation tax due date, then the company must pay tax on the overdrawn balance. The rate of this Section 455 tax is linked to the dividend upper rate. It was increased to 33.75% from 6 April 2022 in line with the increase in the dividend upper rate. That means that now it’s more expensive for a company to loan money to a director (the rate previously was 32.5%).
When the Section 455 tax charge arises, it must be paid with the corporation tax for the accounting period (9 months and 1 day after the end of the accounting period). Most importantly, it’s not a corporation tax but a temporary tax that is repaid if the loan balance is cleared.
The tax becomes repayable 9 months and 1 day after the end of the accounting period in which the loan is repaid. It is usually set against the corporation tax for the period, or repaid to the company if there is no corporation tax to pay. The repayment of the Section 455 tax is not made automatically – it must be claimed.
Close companies will need to keep in mind the higher Section 455 charge when making loans to directors that will not be repaid by the corporation tax due date.
When deciding whether to clear the loan, you will need to look at the whole picture. It is only worth paying a dividend or bonus to clear the loan if the tax consequences are smaller than paying the section 455 tax.
Otherwise, it’s better to leave the loan outstanding and pay the tax. If the director has several loans made over a different period, it makes sense to clear those made on or after 6 April 2022 first. More information on the best order of repayment can be found on our previous blog.