A director’s loan is the funds a director deposits into and takes from the business that fall outside of expense expenses, salary or dividends. Directors’ loans can be with the director lending the company money or taking money out.
A record of these withdrawals and deposits are shown on a director’s loan account. This record will establish whether or not the loan account is overdrawn, confirming the tax implications for the director and the company.
The Companies Act 2006 sets out the rules and requirements for directors’ loans.
Drawing down on an outstanding loan
If a director has a balance available on their director’s loan account, they can draw funds from 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, ie the account is overdrawn this will potentially create tax issues.
What is an overdrawn Director’s Loan Account?
If a director has withdrawn more funds than were available funds in the loan account, the account is said to be overdrawn. Essentially the director owes the company money. In this case there will be two tax implications the director needs to be aware of:
Corporation tax charge – Section 455 Tax Charge
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 tax charge. 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 benefits 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. But it can take some time to recover this tax if you do not repay the loan within nine months of the end of the corporation tax period.
The loan account balance must be shown on supplementary pages of the company’s corporation tax return (CT600).The S455 charge is calculated as 33.75% of whatever balance was outstanding on the 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 £20,000 this year, you would only pay S455 this year on the additional £5,000, not the entire £20,000.
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).
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 tax return for Benefits in Kind is called a P11D. 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 summarises 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 may need to draw up aspects of your books to the end of the tax year to complete your P11Ds.
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. 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
An overdrawn directors loan account will increase the accounting disclosures that are required as required by Section 413 of the Companies Act 2006. Alongside the tax reporting requirements, companies need to be aware of their accounting reporting requirements.
The information required includes:
- Its amount
- an indication of the interest rate
- its main conditions
- any amounts which are repaid, written off or waived.
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. The rules match repayments against later loans, 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 and then take out a new one, as HMRC may view this as tax avoidance.
How to deal with an overdrawn director’s loan account
There are options on how to deal with an overdrawn director’s loan account, these include:
As a starting point, if the director has the funds to repay the loan, this can 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.
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 in Kind Rules
The interaction between S455 and the benefits in Kind rules can lead to some unexpected consequences:
- A S455 charge may be mitigated by a 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.
A director’s loan account that is in credit
Another scenario is where the directors loan account is in credit and the company owes the director money.
In this case, the director can consider whether additional remuneration in the form of interest income would be beneficial. 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 the director, the interest received will be subject to income tax at the savings rates. 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, but it is not available for additional rate.
Record keeping
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.
Remuneration package
It is a good idea for the director to map out their remuneration package. This will set out how much you can draw, when and in what form, this way you won’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.