Owner managers who are both shareholders and directors of their own limited company will often either lend money to, or borrow money from, their companies, which are both accounted for as a Director’s Loan Account (“DLA”). Dividends, salary and business expenses paid for by the director may also get credited to these loan accounts and personal expenses paid for by the company may get deducted through the DLA.
Whether the account is overdrawn or in credit, there are benefits and drawbacks to both, which we will discuss in more detail below.
The Good
Where a director’s loan is in credit, there are no immediate tax implications. This is simply a business owner lending money to their company, to fund business activity. The loan can be drawn upon freely with no income tax arising on any amount withdrawn.
Charging Interest
Like any lender, a director can charge the company interest on the amount that is lent. Should they choose to do so, there are several administrative points to note, discussed below.
Each time interest is paid on the loan, the company must withhold basic rate tax of 20% and pay this over to HMRC via a form CT61. The form CT61 is due for submission 14 days after the quarter end in which the interest is paid (with the quarters being March, June, September and December). We would therefore recommend paying interest on an annual basis in order to ease the administrative burden.
Corporation Tax relief is available to the company on the gross amount of interest paid, as long as this is at a commercial market rate and paid/credited within 12 months of the year end. What is a commercial market interest rate should be considered on a case by case basis taking into account the terms of the loan such as security and repayment terms, as well as the company’s financial position, but interest could be in the region of 5% to 15% per annum currently.
The director will need declare this interest received on their self-assessment tax return for that year, including both the gross payment and tax withheld. Interest receipts can be quite tax efficient for owner managers who may typically have a low salary and dividend income, due to the personal savings allowance and the Nil rate starting band.
For example, a director who has no income other than a salary of £9,000 and dividends of £30,000 from his company could receive interest of up to £9,570 tax free, whilst his company saves Corporation Tax at a rate of 25%.
The Bad
If a director has borrowed money from the company the account will be “overdrawn”, which will trigger a number of tax implications depending on the amount taken.
Benefit In Kind
If at any point during a tax year the total overdrawn amount exceeds £10,000 for a period of more than 30 days, the director will attract a Benefit In Kind (“BIK”) on the notional interest deemed to arise on the loan. This BIK will need declaring on a form P11D (alongside any other benefits such as a company car or medical insurance). The company will need to pay Class 1A National Insurance (currently at 13.8%) and the director will pay income tax on the BIK, usually reported and payable via their self-assessment tax return.
However, a BIK can be avoided if the company charges interest on the overdrawn amounts. The minimum rate of interest required is set by HMRC and is currently 2.25% per annum. This interest is taxable income in the hands of the company, and is therefore subject to corporation tax (19% to 25%). The interest should be paid by the director by 6 July following the end of the tax year.
If the total overdrawn amount does not exceed £10,000 during a tax year, no benefit in kind will arise, meaning no interest needs to be charged.
Note that the above rules don’t just apply to loans to directors but will equally apply to loans taken by any employees of the company.
S.455 Charge
Irrespective of the amount of the overdrawn balance at the company’s year end, if any is still outstanding 9 months after the end of the company’s accounting period, there is a charge to tax for the company under S.455 CTA 2010, known as “s455 tax”.
Although we often use the term ‘Director’ when discussing loan accounts, s455 tax only applies to loans to ‘participator’, which is, broadly speaking, someone with shares in the business and only applies to “close companies” which is broadly those with 5 or fewer shareholders or where all of the shareholders are also directors.
The amount of S.455 tax payable is 33.75% (i.e. the higher rate of dividend tax) of any outstanding loan balance not repaid within nine months and one day after the end of the accounting period. The tax is payable by the company and is payable via the company’s Corporation Tax return.
Unlike other taxes, tax paid under S.455 acts like a deposit with HMRC and is repayable once the overdrawn amounts are repaid by the director. If the director makes a partial repayment, part of the tax under S.455 is repaid to the company by HMRC. The company is entitled to the repayment of a S.455 charge nine months after the year end in which the loan is repaid.
Exclusions to s455
The S.455 charge won’t arise in the following situations:
- A loan made where the company carries on a business of money lending and the loan was made in the ordinary course of that business activity; or
- A loan made to the trustees of a charitable trust; or
- A loan made to a director or employee of a company, provided the amount does not exceed £15,000, and the individual’s interest in the company is less than 5%.
“Bed and Breakfasting” rules
Prior to 2016, it was possible to repay the overdrawn amount 9 months after the year end and take out a new loan a few days later, effectively avoiding the tax charge without repaying the loan.
Movements such as these are known as ‘Bed & Breakfasting’ and HMRC brought in rules in 2016 to stop this from happening.
The rules can trigger in one of two ways:
- The 30-day rule. This rule comes into play where, within a 30-day period of making a repayment of £5,000 or more, the director withdraws additional money from the company via their director’s loan. In such instances, the rule simply ignores the repayment for the purpose of S.455 tax and looks through the transaction, and the charge is still due in full.
- The arrangements rule. This rule takes effect where the balance of an outstanding loan immediately before repayment is at least £15,000, and at the time the loan repayment is made, there is the intention to subsequently borrow at least £5,000. If this happens, the difference between the repayment and the additional borrowing is what is classed as the ‘actual repayment’, with S.455 still required on the remaining balance.
Both rules can work together or separately, so need to be taken into consideration when any tax planning around the S.455 charge is undertaken.
Taxable income such as dividends and salary credited to the loan account are not affected by these rules.
The main takeaway here is that calculating what s455 tax may be due can be complicated and is an area where we regularly provide advice to our clients.
The Ugly
Writing off an overdrawn DLA
The company can write off a Director’s Loan Account at any point, by means of a formal waiver. The release of a loan to a director who is also a shareholder is a deemed distribution or dividend and creates a charge to income tax.
Additionally, it is generally accepted that the deemed dividend is subject to class 1 national insurance for both the company and individual, making it an expensive form of repayment.
It is however a useful option in certain situations, e.g. should the company not have sufficient reserves to declare a dividend to clear the loan balance, or the individual not have the funds to repay the amounts owing.
Liquidating a company that has an overdrawn DLA
Should the company go into liquidation (the process of closing a company down), a liquidator is within their rights to demand that the director repays any outstanding loan balance. The liquidator can take legal action and even make the director bankrupt.
Needless to say, should the company be looking at ceasing to trade, the position with regards to overdrawn Director’s Loan Accounts should be carefully reviewed.
Summary
Overall, a Director’s Loan Account can be a useful tool when it comes to cashflow and remuneration planning.
If this is an area you would like more advice on, please do not hesitate to contact a member of BHP’s Corporate Tax team.
