Loans to Directors

Funds can be made available by a loan. Although there are tax consequences of making loans, it is possible for the director to have the use of the money for up to 21 months for a minimal cost. The rules also apply where a director’s current account is overdrawn.

Under the close company rules for loans to participators, a corporation tax charge arises on the outstanding loan balance if the loan has not been repaid nine months and one day after the year end (the normal corporation tax due date). The charge is 32.5% of the loan balance (equal to the higher rate of dividend tax). This is known as a ‘section 455’ charge.

An income tax charge will also arise under the benefit in kind legislation if the director has loans outstanding at any point in the tax year with a balance of ￡10,000 or more if the loan is interest-free or if the interest paid on the loan is less than that payable at the official rate (set at 2.25% from 6 April 2020 and at 2.50% for 2019/20). If the loan is repaid by the corporation tax due date, there is no section 455 tax to pay. The benefit in kind charge, should one arise, will be cheaper than paying interest on a commercial loan. In this way, a loan from the company can be a cheap source of funds.

It should be noted that anti-avoidance provisions apply to prevent the loan being repaid to avoid the tax charge and the funds subsequently being re-borrowed within a 30-day period or where there is an intention to re-borrow the funds at the time the repayment is made (even if this is outside the 30-day period). However, the anti-avoidance provisions do not apply to repayments and reborrowing of less than ￡5,000, providing limited planning opportunities to reduce the tax payable.

Example

Ivan is a director of a family company. The company prepares accounts to 30 November. On 1 December 2018 Ivan borrowed ￡40,000 from the company. This is at the start of the accounting period to 30 November 2019. The loan is repaid on 25 August 2020, which is within nine months of the accounting period end. Consequently, there is no tax to pay on the loan balance. However, Ivan must pay a benefit in kind charge on the loan. This spans three tax years.

The loan is outstanding for 126 days in 2018/19 and the official rate of interest is 2.50%. The cash equivalent of the benefit is ￡345 (￡40,000 x 2.50% x 126/365). Assuming that Ivan is a higher rate taxpayer, he will pay tax on the benefit of the loan of ￡138. The company will pay Class 1A NIC of ￡47.61.

The loan is outstanding for all of 2019/20. Assuming, the official rate of interest is 2.50%, the cash equivalent of the benefit is ￡1,000 (￡40,000 @ 2.50%), costing Ivan ￡400 in tax and the company ￡138 in Class 1A NIC.

In 2020/21, the loan is outstanding for 142 days. The official rate of interest is 2.25%, the cash equivalent of the benefit is ￡350 (￡40,000 @ 2.25% x 142/365).The associated tax payable by Ivan is ￡140 and the Class 1A NIC payable by the company is ￡48.30.

Ivan has the use of ￡40,000 for almost 21 months for a total cost of ￡912 (tax of ￡678 and Class 1A NIC of ￡234).This is equivalent to an interest rate of 1.3% – considerably less than if he had taken out a commercial loan.

Small Loans To Directors

As illustrated above, making a loan to a director can be advantageous.

Under the benefit in kind rules, no tax charge arises in respect of an employment-related loan if the balance outstanding on the loan does not exceed ￡10,000 at any point during the tax year.

This means that it is possible for a director to enjoy a tax-free loan of up to ￡10,000 for up to 21 months free of charge.

Beware of the temptation to repay the loan and immediately reborrow the money as HMRC may issue a challenge as anti-avoidance provisions render repayments of more than ￡5,000 ineffective if the funds are re-borrowed within 30 days.

If you are unsure about funds in your Loan account or current account, seek advice from your accountant. At 3E'S Accountants we have helped many of our clients to structure their current and loan account to minimise tax implication and provided with best tax strategy to extract funds.