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A director’s loan account is merely a way to keep track of the transactions that take place between the director and his or her own personal or family business. However, there are tax ramifications for the company if the director owes money to the company and the loan remains due nine months and one day after the end of the accounting period in which it was made. This is the day when the corporate tax for the period is payable. If this is the case, the company must pay a tax of 32.5% of the overdrawn amount (Section 455 tax).
Avoiding a Section 455 tax charge
It is possible to avoid a Section 455 charge by paying off the outstanding loan sum prior to the corporation tax due date. However, anti-avoidance rules exist, and care should be taken not to fall foul of these rules. The rules are aimed to guarantee that any repayments are genuine and not transactions intended to evade the Section 455 charge.
Rule 1: The 30-day rule
The 30-day rule applies when a participant borrows from the company again within 30 days after being repaid £5,000 or more. Section 455 tax is due on the lesser of the returned loan or the reborrowed loan. This regulation invalidates the payback if the funds are re-borrowed within 30 days. The 30-day timeframe applies equally to both loan repayment and new borrowing. This stops a participant from taking out a new loan to pay off the previous.
Rule 2: The intentions and arrangements rule
The intentions and arrangements rule allows the taxman a second chance when the 30-day rule does not apply due to the length of time between repayment and new loan. This rule uses a motivation test and may detect repayments and new borrowings made more than 30 days apart.
The intention and arrangements rule applies when the outstanding loan sum is at least £15,000, and there are plans to borrow £5,000 or more in the future. This rule applies even if the new borrowing is beyond 30 days old. The rule applies if the repayment is made with the intention of withdrawing at least £5,000 from the payment, regardless of when it is done. So waiting 31 days before reborrowing won’t work. The rule does not apply to dividends, salaries, or bonuses, since they are subject to income tax.
Genuine repayment
Clearing an outstanding loan debt to avoid a Section 455 charge is only tax-efficient if done via dividend, bonus, or salary payments, which are taxed separately, or by utilising money from outside the company.