A directors’ loan account can be in credit or it can be in debit. If the directors’ loan account is in credit, the company owes you money. If it’s in debit, you owe your company money.
Companies borrowing money from their directors happens all the time, particularly when a business is being started or a director is lending the firm money to grow. It makes far more sense (in most cases) to fund a company through loans you are repaid rather than paying them in via the issuance of addition shares.
Conversely, company directors taking loans out from their businesses is a very common way of being paid. A loan is issued and then, over the course of the following weeks and months, it will be paid back to the company with the issuance of salary, expense re-claims, and dividend payments.
If you owe money to your company because it has lent you money, this is often referred to as an “overdrawn directors’ loan account”.
What do you need to know about directors’ loan accounts?
BusinessCostSaver note – this article makes references to directors’ loan accounts in close companies – they are generally business with five or fewer participators (normally shareholders, directors, or shareholding directors who exert financial control over an incorporated limited company).
Always keep an eye on your directors’ loan account
HMRC have long been worried about the “free flow” nature of directors’ loan accounts.
Money going into it, money coming out of it – it’s all very fluid because a directors’ loan account tends to be reconciled and reorganised at the end of the year. Depending on how an accountant manipulates a directors’ loan account, it can lead to substantial tax savings for an individual.
If your directors’ loan account is overdrawn at the end of year, expect HMRC to want to inspect why.
These things need to happen to allow a company to lend money to its director:
- the company is not in financial dire straits
- it’s in adherence with the company’s articles of association
- it complies with the 2006 Companies Act
- if under £10,000, shareholder approval is normally not need
- if over £10,000, shareholder approval is given at a board meeting by ordinary resolution
- if the money is needed to meet company expenditure, it can be no more than £50,000.
S.455 corporation tax – when you borrowing money from your company and you don’t manage to pay it back within a certain time
When directors take out loans from their company, there is normally no interest charged by the company on the loan.
If a director takes out money from their business in the form of a loan, there will be no additional tax for the company to pay on it if it’s paid back nine months after the end of the company’s tax year.
If you still owe money nine months after the end of the company’s tax year, there will be an additional corporation tax levied on your profit called S.455.
S.455 is charged at 32.5% of the outstanding loan or loans amount.
For an example, you borrowed £30,000 from your company in June 2020. Your company end-of-year is 31st March 2021. That means that you have nine months after 31st March to pay back the £30,000 – that is, 31st January 2021.
But what if you couldn’t repay any of the £30,000? You’d have to enter 32.5% of that onto the S.455 section of your CT600 corporation tax return. So, your corporation tax bill would rise by £9,750.
If you paid your overdrawn directors’ loan account down by £10,000 leaving the balance at £20,000, your company would have to pay 32.5% of that £20,000 in S.455 corporation tax.
BusinessCostSaver tip – for the avoidance of doubt, S.455 is paid by your company and not by you personally.
You can claim this money back but you’ll have to wait.
Is there interest on an overdrawn directors’ loan account?
No, but you will pay interest on the amount of the overdrawn directors’ loan account if you’re late paying your Corporation Tax bill.
Refunds on S.455 corporation tax payments
Once you pay the money you owe back in full, your company will be entitled to get its £9,750 S.455 corporation tax payment back
HMRC are in no hurry though.
Let’s think about the director whose company paid £9,750 in S.455 corporation tax. Let’s say that she managed to pay the loan back in its entirety in April 2020.
When you claim back the S.455 corporation tax payment, you’ll only receive it 9 months after the end of your accounting year. For our company here, the next year of year after April 2020 is January 2021.
The £9,750 would be received at the end of January 2021. Even though she had paid back her loan in April 2019, her company will have to wait another 21 months to receive it.
When you claim an S.455 corporation tax payment back, you use Form LP2. You can do this online although you will need your Government Gateway ID to go through the process.
Are there ways to offset or mitigate S.455?
There are lots of different ways.
You can declare dividends but only if retained profit exists in the business at the time when the dividend is declared. Remember that you start having to pay personal tax on dividends when you have received £2,000 or more of them in a financial year.
You can pay yourself a bonus but be careful as this might incur hefty charges in income tax, National Insurance Employees’ Contributions, and National Insurance Employers’ Contributions. You will have to pay the tax on your next payslip via PAYE using Real Time Information.
You can do a mixture of both if there is some retained profit that can be declared as dividends or not. Again, be wary about income tax, National Insurance Employees’ Contributions, and National Insurance Employers’ Contributions charges.
BusinessCostSaver tip – whenever salary or a salary-based bonus is paid to offset an overdrawn directors’ loan account, that salary must be reported via Real Time Information prior to transfer.
All of these methods are paper exercises. You and your bank account never personally see the money. Your accountant will simply move various figures into different columns and make the required declarations for HMRC.
You can get your accountant to make sure that all personal allowances due are paid into your overdrawn directors’ loan account – items like business mileage.
If you personally own any assets that the company uses, you can “sell” them to the company – and that includes your car. The sale must take place at market value. This is another paper exercise where you will not personally feel the benefit of cash entering your personal account.
BusinessCostSaver tip – you won’t be able to sell any vintage cars to your company without potentially incurring capital gains tax.
You may have more than one director’s loan account. One might be in credit and the other in debit. However you choose to raise money to put into a loan account, get your accountant’s advice on the correct allocation of dividends, bonuses, salary, and so on into the most beneficial account for tax purposes.
BusinessCostSaver tip – HMRC may wish to aggregate however many directors’ loan accounts you have together to create a tax demand from you. In this case, you will need professional advice to appeal your case.
If this is a family business, you could sign an agreement to the credit in another directors’ loan account against the debit in your directors’ loan account. Make sure this is done as soon as possible and pass a board resolution to that effect.
BusinessCostSaver tip – the S.455 corporation tax payment is only due on the participators in a business (normally shareholders, directors, or shareholding directors who exert financial control over an incorporated limited company), not any non-participator staff member to whom your company has lent money.
Finally, pension savers can now take a 25% lump sum out of their pension pots if they are aged 55 or over without paying any tax. If you so wish, you could use this lump sum to pay off an overdrawn directors’ loan account.
A benefit-in-kind payment is a method of payment to an employee (including a director) that does not take the form of cash. The most common types of benefits-in-kind are company cards, private medical insurance, and loans.
Let’s look at the rules around loans. When thinking about loans for benefit-in-kind purposes, a loan is the total amount of money borrowed over the course of a tax year. That could be one loan or ten loans.
If the total value of all loans taken out by a staff member total £10,000 or less over the course of a year, this is not considered a benefit-in-kind.
If it’s higher than £10,000, different rules apply. Every year, HMRC produces an interest rate for, among other things, loans to staff members. At the time of writing, that rate is 3%.
If you lend money to a member of staff in excess of £10,000 a year where there is either no interest or the interest rate is under HMRC’s rate, a benefit-in-kind is produced because your staff member is getting that loan at a cheaper rate than they could anywhere else.
In these cases, and this includes company directors with shareholdings who take money out of the company, the person must pay tax on the difference between what they have paid in interest and what they would have paid in interest at the HMRC rate. The amount of tax the employee pays is consistent with their normal level of tax (20%, 40%, or 45%)
When declaring this type of benefit in kind, you must use form P11D Working Sheet 4.
Can I write the loan off?
You can, but there are dangers. First, we’ll look at the mechanism.
If the money has been borrowed by a participator, then it can be written off and the amount written off is treated as a distribution (like a dividend payment).
If the person is not a participator, it will be treated as taxable income – that is subject to income tax and National Insurance Employees’ Contributions for them and National Insurance Employers’ Contributions for you.
For participators, it must be written off via a resolution passed at a board meeting.
There may be National Insurance consequences to a write off for the person, Class 1 National Insurance contributions are payable by your company, and, because it is distributed in the same way as a dividend, it’s not an expense so it won’t lower profits to bring down your Corporation Tax.
If you have paid the S.455 corporation tax on the overdrawn amount, you make a claim for the money back from HMRC for your company using Form LP2.
Insolvency and overdrawn directors’ loan accounts
If your company goes into liquidation soon after a loan has been written off, expect an insolvency practitioner to question the circumstances under which the write-off happened. The practitioner may view this as an action that is prejudiced against the company’s creditors.
If your loan remains unpaid and you’ve paid the S.455 corporation tax supplement, the insolvency practitioner will still consider the money as outstanding and will be within his or her rights to chase the money from you.
Other directors’ loan account points
HMRC will be on the lookout for “bed and breakfasting” arrangements. This is where you pay off your loan just before the end of the period lasting 9 months after the end of your company tax year and a new loan is made to you shortly thereafter.
If a director with an overdrawn loan account dies, the amount that is written off will be treated as the director’s taxable income. For National Insurance purposes, any loan that is written off will be considered and treated by HMRC as taxable if HMRC deems it as pay or employment-derived profit.