A director’s loan account is simply a mechanism for recording transactions between the director and the company. In a family or personal company situation, transactions between the director and the company are commonplace. The director may lend money to the company or borrow from it, the director’s behalf and salary or dividend payments may be credited to the account. However, there are tax consequences if the account is overdrawn at the year end and remains so at the corporation tax due date.
One of the main benefits that may be available to a director of a personal or family company is the ability to borrow easily and cheaply, assuming that the company has the funds available. The rules make it possible for the director to borrow up to £10,000 for up to 21 months without any tax consequences. If the amount exceeds £10,000 – even for as little as one day – there will be a benefit in kind charge to pay on the loan. However, this is likely to be significantly cheaper than the cost of a commercial loan, and will not entail the costs and restrictions inherent in obtaining a commercial loan. If the directors loan account is overdrawn at the end of the accounting period and remains overdrawn at the time at which the corporation tax for the period is due nine months and one day after the year end, the company is required to pay a tax charge on the outstanding loan balance (a ‘section 455’ charge). The charge is 32.5% of the outstanding loan balance and is payable with the corporation tax for the period. The rate of tax is the same as the higher rate of tax on dividends.
The section 455 tax can be avoided if any overdrawn loan account balance is cleared before the corporation tax due date. However, this will not always be the most tax-efficient option as depending on the route taken to clear the debt, the tax payable may be more than the section 455 tax. Further, the section 455 tax is repaid if the debt is cleared at a later date, with the repayment being due nine months and one day from the end of the accounting period in which it was cleared. This paves the way for paying the section 455 tax initially, clearing the loan at a later date when this can be done tax effectively and reclaiming the section 455 tax. If the director has sufficient funds to clear the debt, this will be beneficial from a tax perspective as it will prevent a section 455 charge from arising without triggering tax liabilities on the director. Whether it is worthwhile to pay the director a bonus or a dividend payment to clear the loan account will depend on the director’s personal circumstances – if this can be done tax-free or at a low rate of tax, it may be preferable to paying the section 455 charge. However, if the taxpayer is a higher or additional rate taxpayer, paying the section 455 tax will be the cheaper option. Remember, not only will the bonus or dividend need to be sufficient to clear the debt, it will also need to cover any associated tax and National Insurance.