Directors of limited companies sometimes need to take personal loans from their companies for various reasons. However, it is important to understand the tax implications of such director's loans and the rules surrounding the payback period to avoid potential tax liabilities, particularly under Section 455 (S.455) of the Companies Act. This article aims to provide an overview of the tax considerations associated with director's loans and the rules for timely repayment to avoid S.455 tax.
1. Director's Loans and Tax Implications:
When a director borrows funds from their limited company, it is treated as a director's loan. The tax implications of such loans are as follows:
a. Tax on Overdrawn Director's Loan Accounts:
An overdrawn director's loan account arises when a director's loan exceeds any funds they have introduced or any salary or dividend payments they have received.
If the loan remains outstanding at the end of the accounting period, it can give rise to tax consequences, including potential tax charges under S.455.
b. Section 455 Tax:
S.455 tax is a mechanism to deter directors from using their companies as personal banks.
It applies when a director's loan remains outstanding more than nine months after the end of the accounting period in which it was taken.
The company is liable to pay S.455 tax, which is currently set at 32.5% of the outstanding loan amount.
The tax is payable by the company and can be reclaimed by the company when the loan is repaid or released.
2. Timely Repayment and Avoiding S.455 Tax:
To avoid the imposition of S.455 tax, it is crucial to understand the rules regarding timely repayment of director's loans. Here are the key considerations:
a. Repayment within Nine Months:
To prevent the company from incurring S.455 tax, the director's loan must be repaid in full within nine months after the end of the accounting period in which the loan was taken.
Repayment includes either returning the funds to the company or offsetting the loan against any salary, dividends, or other outstanding payments owed to the director.
b. Avoiding Subsequent Nine-Month Cycles:
If a director repays their loan but subsequently withdraws funds again, a new nine-month period begins for the newly withdrawn loan.
To avoid ongoing cycles of repayment and potential S.455 tax charges, careful monitoring and prompt repayment of subsequent loans are essential.
3. Alternative Options for Repayment:
If a director is unable to fully repay their loan within the nine-month period, alternative options can be considered to avoid or mitigate S.455 tax consequences:
a. Charging Interest on the Loan:
Charging interest on the director's loan is an effective way to demonstrate that the loan is being treated as a genuine borrowing arrangement.
The interest charged should be at a commercial rate, and relevant documentation should be maintained to support this arrangement.
b. Declare a Dividend to Clear the Loan:
If the company has sufficient distributable profits, a dividend can be declared to clear the outstanding director's loan.
It is important to ensure that the dividend is lawful and compliant with the relevant regulations.
Taking a director's loan through a limited company can have tax implications, particularly if the loan remains outstanding beyond the nine-month period. By understanding the rules and obligations surrounding timely repayment and avoiding S.455 tax, directors can manage their personal financial needs while ensuring compliance with tax regulations
If you want more detailed advice on the above, please speak to one of Ember's accountants who will be able to help with your particular situation!