Convention has it that in times of high interest rates, director loans borrowing from your company is invariably more tax efficient than borrowing from other sources such as a bank. However, this may not always be the case. If the director loans cannot be repaid within nine months and one day after the company’s accounting year end, the company will be liable for a tax charge equal to the dividend upper rate (35.75%). Without this charge, the director could borrow money from the company indefinitely without ever paying income tax or NIC on the amount withdrawn. In addition, where a beneficial loan exists, the director may face an income tax charge on the benefit, while the company pays Class 1A NIC. This applies regardless of whether the loan is repaid.
Company charge
The tax charge is technically temporary as, should the company be liable, the payment will be refunded when the loan is repaid (or written off.) The refund is usually offset against the corporation tax bill due, nine months and one day after the accounting year end in which the loan is repaid, with no interest received. If no corporation tax is due and a cash refund required, HMRC will not refund until after the same nine-month period has passed. This delay could create serious cash flow problems for the company.
Director’s charge
A separate set of rules applies entirely independently of the company’s charge, designed to catch the benefit to the director of having an interest-free (or below-market-rate) loan. If the director loans balance exceeds £10,000 at any point during the tax year (even for one day), the director is treated as receiving a taxable benefit in kind equal to the notional interest on the loan, calculated using HMRC’s official rate (currently 3.75%). Income tax is levied at the director’s marginal tax rate on the difference between any interest charged and the ‘official rate’, such loans termed ‘beneficial loans’. The company must also pay Class 1A NIC at 15% on the same amount.
The benefit in kind and employer’s NIC can be avoided by levying interest on the director loans at the official rate (or above), even if rolled up in the loan, rather than immediately paid. If the ‘official rate’ is charged, borrowing from the company is cheaper than a bank loan or credit card.
Planning to clear the loan
Not repaying the loan on time can produce significant tax charges on both the company and the individual. Therefore, unless repayment is made on the sale or winding-up of the company, settlement will have to come from personal savings, by taking taxable income from the company (e.g. dividend) or by further external borrowing. In practice, paying a bonus or dividend to clear the loan is the cleanest route, but this triggers income tax (on a bonus) or dividend tax, so the ‘free loan’ turns out not to have been free at all.
For a basic taxpayer, it would be cheaper to convert the loan into a dividend taxed at 10.75% rather than have the company pay the 35.75% charge. Conversely, where the director is an additional rate taxpayer, it may be cheaper for the company to suffer the charge, as this is ultimately repayable when the loan is repaid or written off. For a higher rate taxpayer there would be no difference. However, even when tax does have to be paid, the shareholder can still end up with more initial funds through a loan than through additional salary or dividends, having benefited from interest-free or low-interest borrowing in the meantime.
Some directors repay using borrowed money by taking out a personal loan or 0% credit card, repaying over time. This can work, but needs careful planning, as personal loans carry interest costs and 0% credit card deals have time limits.
Practical point
Borrowing from the company only makes sense for basic rate taxpayers who require short-term loans e.g. where a dividend will be declared shortly after year end and the loan cleared promptly. Treated as a long-term financing tool, it is almost never tax efficient. However, the s455 charge is only temporary and any benefit in kind may be less than the cost of external borrowing.
Partner note:
CTA 2010 (ss455, 458, 459, , 464C–D) for the company side
ITEPA 2003 (ss175–181) for the director’s benefit
HMRC guidance:
Company Taxation Manual:
- CTM61505 – Loans to participators: overview
- CTM61650 – Repayment of the s455 charge
- CTM61630 – Loans written off: income tax treatment
- CTM61665 – Anti-avoidance rules
