Transactions between a director and his or her personal or family company are common and a director’s loan account is simply an account for recording the transactions that occur between the two.
However, there are tax consequences for the company if the director owes money to the company and the loan remains outstanding nine months and one day after the end of the accounting period in which it was made. This is the date that the corporation tax for the period is due. Where this is the case, the company must pay tax (Section 455 tax) of 32.5% of the overdrawn balance.
Avoiding a Section 455 tax charge
A Section 455 charge can be avoided if the outstanding loan balance is cleared before the corporation tax due date. However, anti-avoidance rules apply, and care should be taken not to fall foul of these rules. The rules seek to ensure that any repayments are genuine repayments, rather than transactions designed to avoid the Section 455 charge.
Rule 1: The 30-day rule
The 30-day rule comes into play where, within a period of 30 days of a repayment of more than £5,000, the participator borrows again from the company.
Section 455 tax is payable on the lesser of the amount of the loan repaid and the amount re-borrowed. This rule renders the repayment ineffective to the extent that the funds are re-borrowed within 30 days.
It doesn’t matter which comes first, the loan repayment or the further borrowing, the 30-day period applies equally. This prevents a participator from taking out a new loan and using it to repay all or part of the original one.
Rule 2: The intentions and arrangements rule
The intentions and arrangements rule gives the taxman a second bite of the cherry where the 30-day rule does not apply because the period between the repayment and the new loan is more than 30 days. This rule applies a motive test and can catch repayments and further borrowing more than 30 days apart where the intention is to avoid tax.
The intention and arrangements rule comes into play where the balance of the loan outstanding immediately before the repayment is at least £15,000 and, at the time a loan repayment is made, there are arrangements, or an intention, to subsequently borrow £5,000 or more.
This rule applies even where the new borrowing is outside 30 days. The rule bites if the repayment is made with the intention of redrawing at least £5,000 of the payment, irrespective of when this is done. This means waiting 31 days before re-borrowing the funds will not necessarily work.
Again, the rule does not apply to funds extracted by way of a dividend, salary or bonus, as these are within the charge to income tax.
Clearing an outstanding loan balance to avoid a Section 455 charge will only be tax-effective if this is done either by means of dividend, bonus or salary payment, which attract tax charges in their own right, or by using funds from outside the company to make a genuine repayment.
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