Tax implications of making loans to directors

Where a family company has cash in the bank but profits have been adversely affected, the directors may take a short term loan to enable them to meet personal bills. This loan can be cleared with a dividend payment when business picks up. There are tax implications to be aware of if the loan balance exceeds £10,000, or if the loan is not repaid by the corporation tax due date.

A tax-free loan

It is possible to enjoy a loan of up to £10,000 tax-free for up to 21 months. To enjoy the maximum tax –free period, the loan must be drawn on the first day of the accounting period. If it is taken out during the accounting period, as long as it is does not exceed £10,000, it can be enjoyed tax-free, until nine months and one day after the accounting year end.

Provided the loan is for £10,000 or less, there is no benefit in kind tax to pay. If the outstanding loan balance exceeds £10,000 at any point, the director is taxed on the loan benefit.

Section 455 charge (S455)

To avoid a S455 charge, the loan must be repaid within nine months and one day of the accounting year end. This is when the corporation tax payment is due. The S455 charge is a charge on the company set at 32.5% of the outstanding loan balance. The charge is aligned with the higher dividend tax rate.

If the loan is cleared by the corporation tax date, there is no S455 tax to pay. There are various ways in which the loan could be cleared; either by declaring a dividend (assuming there are sufficient retained profits) or by paying a bonus. However, there will be tax implications of these too. Unless the director can use funds from outside the company to clear the loan or will pay tax on the dividend or bonus being used to clear it at a rate which is less than 32.5%, it may be better to pay the S455 charge instead.

The S455 charge is a temporary charge which is repaid if the loan is repaid. The repayment is made nine months and one day from the end of the accounting period in which the loan was repaid. It is usually set off against the corporation tax liability for that period.

Anti-avoidance provisions apply to prevent a director from clearing the loan close to the corporation tax due date and re-borrowing the funds soon afterwards.

Benefit in kind charge

A tax charge arises on the director if the loan balance exceeds £10,000 at any point in the tax year. The charge is the difference between interest due on the loan (2.25% since 6 April 2020) and the interest paid by the director. The company must also pay Class 1A National Insurance (at 13.8%) on the taxable amount.