Directors and shareholders in close companies are often able to influence the payments that are made to them. Broadly, a close company is one that is controlled by five or fewer shareholders. Personal companies and most family companies are close.
In a close company, there are often numerous transactions between the director and the company – the company may, for example, make payments to the director, loan money to the director and may also make payments on the director’s behalf. On the other side of the coin, the director may loan money to the company, repay loans or make payments on the company’s behalf. The director’s loan account provides the means for keeping 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.
The corporation tax for an accounting period is due for payment nine months and one day after the end of the accounting period. If the loan is repaid in this period (or the overdrawn balance cleared), there are no further tax consequences. However, the loan must be reported on the company’s corporation tax return. Depending on the amount of the loan, there may also be a benefit in kind tax charge for the director, and a Class 1A National Insurance liability on the company. This will be the case if the amount owed by the director to the company exceeds £10,000 at any point in the tax year.
An overdrawn account can be cleared in various ways, for example, by paying money into the company from personal resources, crediting a bonus or salary payment to the account or by declaring a dividend. It should be borne in mind that there will be tax and National Insurance contributions to pay on a salary or bonus payment and tax to pay on a dividend.
If the loan has not been repaid and the director’s account remains overdrawn at the corporation tax due date, the company must pay tax on the overdrawn balance. This rate of this tax (Section 455 tax) is linked to the dividend upper rate. Consequently, it was increased to 33.75% from 6 April 2022 in line with the increase in the dividend upper rate applicable from the same date. The increase in the rate means that it is now more expensive for a company to loan money to a director. The rate of Section 455 tax was 32.5% prior to 6 April 2022 (and 25% prior to 6 April 2016).
Where a Section 455 tax charge arises it must be paid with the corporation tax for the accounting period, nine months and one day after the end of the accounting period. Crucially, it is not corporation tax, and also unlike corporation tax it is a temporary tax that is repaid if the loan balance is cleared. The tax becomes repayable nine months and one 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 must be claimed – it is not made automatically.
Personal and family companies will need to budget for the higher Section 455 charge when making loans to directors (or to other participators) that will not be repaid by the corporation tax due date.
When deciding whether to clear the loan, the whole picture needs to be considered. It is only worth paying a dividend or bonus to clear the loan if the tax consequences of doing so are less than paying the section 455 tax, for example, if a dividend would be sheltered by the dividend allowance or taxable at the dividend lower rate. Otherwise, it is better to leave the loan outstanding and pay the tax. If the director has several loans made over different period, it makes sense to clear those made on or after 6 April 2022 first.
Partner note: CTA 2010, s. 455.