Making loans to directors: Tax implications

If your family owned company has cash in the bank but its profits have been severely affected by the current economic scenario, it might be efficient from a taxation point of view to make a short term loan to the directors to meet their personal bills with a view to clearing in the future the loan with a dividend payment when business picks up.

This can be a very tax-efficient strategy, but there are potential 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.

Technically 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 should be taken out on the first day of the accounting period.

Where the loan 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 end of the accounting period of the company.

Provided the loan is for ￡10,000 or less, there is no benefit in kind (BIK) tax to pay for the individual. But if the outstanding loan balance exceeds ￡10,000 at any point, the director is going to be taxed on the benefit of the loan.

Section 455 charge and loan repayment

To avoid a section 455 charge at the company level, the loan must be repaid within nine months and one day of the end of the relevant accounting period. This is the day by which corporation tax for the period must be due (if any).

A section 455 charge is a charge on the company set at 32.5% of the outstanding loan balance. The charge is technically aligned with the higher dividend tax rate.

Please note that 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, for example, by paying a bonus or by declaring a dividend (available only if the company has sufficient retained profits).

However, as expected there will be relevant tax implications of these too. Unless the company 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 at least less than 32.5%, it may be better to pay the s455 charge instead.

It should be highlighted that the s455 charge is a temporary charge which will be repaid only if the loan is repaid.

The repayment is made nine months and one day from the end of the accounting period of the company in which the loan was repaid, usually be setting it against the actual corporation tax liability for that period.

It should be highlighted that anti-avoidance provisions apply to prevent a director from clearing the loan shortly before the corporation tax due date and re-borrowing the funds shortly afterwards (the so called "bed and breakfasting" practice). Bed and Breakfasting is in general said to occur when a director repays the loan in full before their year-end to avoid penalties, to then immediately take another loan, with the intention never repaying it.

A tax charge will also arise on the director under the benefit in kind legislation if the loan balance exceeds ￡10,000 at any point in the relevant tax year.

 The amount charged to tax is the difference between interest due on the loan at the official rate (set at 2.25% since 6 April 2020) and the actual interest, if any, paid by the director of the company.

Please consider that the company must also pay Class 1A National Insurance (at 13.8%) on the taxable amount.

If you need more info, feel free to send an email to [email protected]

Angelo Chirulli

Director of Tax