It can be hard to define the line between the directors and the company with personal and family companies. A director may pay for company bills, whereas the company may pay for the director’s expenditures. A director’s loan account (DLA) can be set up to keep track of transactions between the directors and the company.
Provisions exist, to deter directors from being able to use company money regularly without paying taxes and National Insurance. By imposing a charge on the company if the director takes out a loan, that is outstanding at the corporation tax due date nine months and one day after the end of the accounting period. If the director cannot repay the charge within 9 months of the end of the accounting period, then interest will be added to the Corporation Tax, until the loan is repaid. This charge acts like a loan to the director. This charge only applies if a company is close, which means that the company is under the control of five or fewer participators (usually shareholders). In most cases, these charges are usually incurred by directors, however, other participators can use company money. The charge is usually referred to as the ‘section 455 charge’.
Section 455 tax charge
The section 455 tax charge, is paid at the same time as corporation tax and is reported on the company tax return. Unlike corporation tax, the 455 tax charge is only a temporary tax. which means that once the outstanding loan has been repaid, the company can receive a refund for the corporation tax paid. The charge can be repaid after the end of the accounting period.
Rate of section 455 tax
If a loan was taken out for more than £5,000, then the rate of tax will be applied to the outstanding loan balance at the corporation tax due date. The current rate is set at 33.75%, this was set on 6th April 2022. Previously the rate was 32.5% from 6th April 2016 to 5th April 2022. Before that, the rate was 25% prior to 6th April 2016.
The rate that will be applied to the loan will depend on when the loan was taken out. If a company’s accounting period spans over a rate change, then it is crucial to keep accurate records of when the loan was taken out. Keeping the transaction date will help determine the section 455 tax payable rate.
Benefit in kind
If a shareholder or director owes the company more than £10,000, then the loan needs to be treated as a ‘benefit in kind', This means that the individual taking out the loan has to pay tax on the loan unless the interest paid exceeds the official rate of interest. Class 1A National Insurance will also need to be paid on the taxable amount.
Benefit in kind are the benefits employees or directors can receive from their company, these are not included in salary or wages. They are often considered perks. Some examples are company cars or private health insurance.
Repaying the loan
If the loan is paid before the Corporation Tax due date, then section 455 will not be raised. However, this may not always be tax efficient for an employer and their employees. There are different ways to clear the loan. The first was is by a director using personal funds outside of the company, this way prevents any additional tax charges and National Insurance liabilities. Another way is by paying a bonus (or a higher salary), this way will attract both taxes at the director’s marginal rate and employer’s/employee’s Class 1 National Insurance. If the amount of tax that needs to be paid is higher than the section 455 tax charge, then it is more cost-effective to wait to pay the section 455 tax charge. The last way is by declaring a dividend to clear the loan. Tax will also be incurred from this process, as a tax will need to be paid at the dividend rate, which may lead to paying more tax than the section 455 tax charge. However, if the dividend is able to be sheltered by the dividend allowance or the dividend tax rate is at a lower rate, then it will be effective to use dividends to pay the loan.