However, a company is a separate legal entity meaning, loans made between a company and participators (directors and shareholders) require consideration and planning.
In this article, we take a closer look at the consequences of an overdrawn director’s loan account, how the impact can be reduced or avoided, and the implications of a company owing a participator money.
What is a Director’s Loan Account?
A director’s loan is defined as funds a director deposits and takes from the business that fall outside of an expense repayment, salary or dividends. As a result, directors’ loans can go either way, with the director lending the company money or taking money out.
A record of these withdrawals and deposits are collated on a director’s loan account. This will establish whether or not this is overdrawn and confirm the tax implications for the director and the company.
A director’s loan account is in debit when the director owes money to the company. This means that the director has overdrawn funds from the account. As opposed to being in credit, where the company owes money to the director.
The Companies Act 2006 sets out the rules and requirements for directors’ loans.
We will look at both scenarios, when the account is in debit and in credit.
Drawing down on an outstanding loan
If a director has a balance available on their director’s loan account, they can draw down on this with no tax implications or reporting requirements. It’s effectively like they’ve got a bank account they can just dip into.
However, if more funds are drawn down than available, this will potentially create tax issues.
What is an overdrawn Director’s Loan Account?
The most common scenario is when a director is overdrawn on their loan account.
If a director has exhausted their available funds in the loan account, the account is said to be in debit. Essentially the director is ‘in the red’ and owes the company money. In this case there will be two tax implications the director needs to be aware of:
Corporation tax charge – S455
Firstly, if a ’close company’ has a balance that is outstanding on its loan account at its financial year end, this can lead to a tax charge on the company called a Section 455 (S455). This only applies to ‘close companies’, which are usually companies with less than five shareholders/directors. Further guidance about close companies can be found on the HMRC Revenue & Customs (HMRC) website here.
An overdrawn director’s loan account is effectively an interest-free loan, so S455 is supposed to deter the company from providing such generous perks to its directors. However, S455 is rather unusual in that it is temporary. HMRC will repay the tax paid back to the company as the director repays the outstanding amount back. Please note that it can take some time to recover this tax if you do not repay the loan within nine months of the end of the company's corporation tax period.
From a practical perspective, the loan account balance must be shown on supplementary pages of the company’s corporation tax return (CT600) and the S455 charge is calculated as 33.75%* of whatever balance was outstanding on the director’s loan account at the period end. The S455 tax is payable nine months and one day from the end of the relevant accounting period.
You only pay S455 on any advances on the loan, not the whole loan balance. Therefore, if the loan balance went from £15,000 last year to £18,000 this year, you would only pay S455 this year on the additional £3,000, not the entire £18,000.
Where the loan is repaid within nine months of the end of the accounting period, relief is due immediately, i.e. the S455 is never physically paid (although disclosure is still required in the company’s tax return).
* S455 tax is due at the rate of 33.75% on the outstanding loan balance from April 2022. The rates were 32.5% to April 2022 and 25% for loans made before 6th April 2016.
Beneficial Loan benefit in kind
The second implication of an overdrawn director’s loan account is that a benefit in kind can be triggered for the ‘beneficial loan’ provided. A beneficial loan is made on the basis the loan is provided interest-free, and the director is taxed on the interest that would have been due if it had been a normal loan on the open market. The benefit in kind loan can be calculated two ways, the average method or the strict method.
There are a few exceptions, when a taxable benefit for a beneficial loan does not arise:
- The company charged the director interest (there are criteria surrounding this)
- The loan never exceeds £10,000 throughout the tax year
Guidance on benefits in kind and administration
A return for Benefits in Kind are called P11Ds. You must supply copies of the P11D to HMRC and employees. A form P11D(b) shows the company’s Class 1A National Insurance liability, and these forms need to be submitted to HMRC by 6th July. The P11Ds will summarise what’s happened to the overdrawn director's loan account across the tax year (not the company’s accounting year-end).
This means if your company’s year-end is not 31st March (i.e. in line with the tax year), you will need to draw up aspects of your books to the end of the tax year to complete your P11Ds, if you have an overdrawn director’s loan account.
If your director’s loan account is overdrawn and you think it may exceed £10,000 at any point in the tax year, it is important to complete the P11Ds and P11D(b) on time, where you have not been charged the correct amount of interest for the benefit of the loan. If your P11D(b) is late, you will be charged a penalty of £100 per 50 employees for each month or part month the return is overdue. You’ll also be charged penalties and interest if you pay HMRC late.
Accounting disclosure requirements
Alongside the tax reporting requirements, companies need to be made aware of their accounting reporting requirements.
Guidance for accounting disclosure requirements for any advances a, credit and guarantees which are authorised by a company can be found in Section 413 of the Companies Act 2006. The information required for advances or credits are:
- Its amount,
- an indication of the interest rate,
- its main conditions,
- any amounts which are repaid, written off or waived.
Information required for a guarantee:
- the main terms,
- the amount of the maximum liability that may be incurred by the company (or its subsidiary),
- any amount paid and any liability incurred by the company (or its subsidiary) for the purpose of fulfilling the guarantee (including any loss incurred by reason of enforcement of the guarantee).
Can I repay a director’s loan and then take out another?
The S455 tax charge can’t be avoided by repaying the loan before the year-end, and taking another loan straight back out. Anti-avoidance rules were introduced to combat this type of ‘bed and breakfasting’ arrangements. More specifically, the rules match repayments against later loans, in effect ensuring that only enduring repayments are to be taken into account in giving relief from a S455 charge.
Therefore, you must be careful not to pay off one loan just before the deadline to then take out a new one, as HMRC may view this as tax avoidance.
How to deal with an overdrawn director’s loan account
As with a lot of scenarios, it’s hard to give one solution that will suit everyone’s circumstances.
As a starting point, if the director has the funds to repay the loan, this can be utilised to assist with reducing the balance due to the company. These repayments will allow the company to reclaim the S455 tax paid on the balance repaid, assisting with company cash flow.
If the director does not have the available funds, they can consider declaring a dividend for the director. This is, of course, provided the company is making a profit, and the director is also a shareholder.
As the director is deemed to have received this dividend, there will almost certainly be personal tax payable on the amount declared. Guidance on the income tax rates can be found on the HMRC website.
This dividend declaration could be a one-off hit, whereas the impact of an overdrawn director's loan account can go on year-after-year. Unlike employment income, National Insurance is not be payable on dividend income.
The interaction between S455 and the benefits code
The interaction between S455 and the benefits code can lead to some unexpected consequences:
- A S455 charge may be mitigated by an declaration of a dividend after the year end. However, if the balance on the loan was over £10,000 at some point, then a benefit in kind would arise.
Where a loan remains under £10,000 throughout the year but does not get repaid by the year end or within the nine months following, this would result in a S455 charge being payable, but no benefit in kind would arise.
As you can see, an overdrawn director’s loan account could result in a S455 charge or a benefit – or both.
Record keeping and disclosure
Good record keeping with regards to a director’s loan account is essential. Poor records could result in the misallocation of expenses/ payments and ultimately, the right taxes not being paid, and a note is required in the accounts where a loan account is overdrawn.
Overall, the key is to keep timely, accurate records and to keep the transactions relating to each of the directors and each of their loans separate.
A director’s loan account that is in credit
Another scenario is where the directors loan account is in credit. This is when the company owes the director money.
In this instance, the director can consider whether additional remuneration would be beneficial, in the form of interest income. The director could charge the company interest on the outstanding loan balance at an appropriate rate.
For the company, this interest would be an allowable deduction in the company accounts, allowing relief for the company. When paid in this way, HMRC requires basic rate tax to be deducted from the interest payment and paid over to them. However, the recipient of the interest can claim a credit for this tax on their tax return. HMRC will require a form CT61 to be submitted to confirm the income tax that has been deducted from the interest charges. For more guidance on the form CT61 please click here.
For the director, the interest received will be subject to income tax at the savings rates (0%/ 20%/ 40%/ 45%). This may be effective income tax planning if an individual has a personal savings allowance to utilise. If the individual is a basic rate taxpayer they can earn up to £1,000 which is subject to income tax at 0%. For higher rate taxpayers this 0% tax rate is reduced to £500, and is not available for additional rate taxpayers (HMRC guidance on this can be located here.)
In addition to the above savings allowance, a 0% starting rate of income tax applies for interest income where taxable non-savings income is below £5,000. Where taxable non savings income, such as employment income, can be minimised, this can lead to tax efficient extraction options for directors of limited companies.
With this being savings income, Class 1 National Insurance Contributions (NICs) will not be payable on the income.
Good record keeping with regards to a director’s loan account is essential. Poor records could result in the misallocation of expenses/payments and ultimately, the right taxes not being paid, and a note is required in the accounts where a loan account is overdrawn.
Overall, the key is to keep timely, accurate records and to record the transactions relating to each of the directors and each of their loans separate.
How we can help
If you are experiencing problems with understanding personal expenses and payments with your company, you would probably benefit from mapping out your remuneration package. This will set out how much you can draw, when and in what form, so that you don't have any surprises at the year end. This can also help you plan a more tax efficient remuneration plan to suit your current and future lifestyle.
We offer free initial consultations, advice, and support over the phone or via video meeting if you have any concerns about face-to-face meetings, to book yours, please call 0800 0523 555 or use our online enquiry form.
Date published 3 Jul 2018 | Last updated 11 Jan 2024This article is intended to inform rather than advise and is based on legislation and practice at the time. Taxpayer’s circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this article, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.
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