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Outstanding director’s loan – clear the loan or pay the ‘Section 455’ charge?

As a company approaches its corporation tax due date, a decision needs to be taken whether to clear any director’s loan account balance remaining outstanding from the year end or whether to pay the ‘Section 455’ charge.

Nature of ‘Section 455’ charge

The ‘Section 455 charge’ (imposed by CTA 2010, s. 455) arises where a loan to a director or participator in a close company remains outstanding on the corporation tax due date nine months and one day after the year end.

According to HMRC, “The purpose of the s455 tax charge is to deter companies from making untaxed loans to their participators rather than paying remuneration or dividends which are chargeable as income”.

The rate of ‘Section 455’ tax is the same as the higher dividend rate, currently 32.5%.

A temporary tax

‘Section 455’ tax is unusual in that it is a temporary tax – it is refundable (usually by offset against the main corporation tax liability) nine months and one day after the end of the period in which the loan was repaid.

Is it worth clearing the loan?

The answer, is that it depends. Not all repayments are equal and the repayment mechanism may trigger its own tax liabilities, which may be higher than the ‘Section 455’ tax.

Ways to clear a director’s loan account

  • Using personal funds

  • Where a director has sufficient funds at their disposal, outside of their company, introducing those funds for offset against the overdrawn director’s loan account will normally be a cheaper option, tax wise, provided that accessing the cash, in the first place, does not trigger any additional tax liabilities elsewhere.

  • Declaring a dividend

  • If the company has sufficient retained profits, within its reserves, another option would be for it to declare a dividend to offset against the overdrawn director’s loan account, to either reduce or even clear the loan account balance.

    If the dividend falls within a taxpayer’s:

    • Basic rate band, their income tax charge will be at 7.5%, considerably less than the rate of the ‘Section 455’ tax.

    • Higher rate tax band, the tax payable on the dividend will be 32.5%, the same rate as the ‘Section 455’ tax.

    • However, as the dividend tax incurred will be lost for good, in some circumstances it may be preferable to leave the loan outstanding and pay the ‘Section 455’ tax.

    • Additional rate band, in the short run paying the ‘Section 455’ tax will be the cheaper option.

  • Paying a bonus

  • Another option available is to pay a bonus to clear a director’s loan account. However, while deductible for corporation tax purposes, it will attract income tax and Class 1 National Insurance costs.

Do the sums

There is no substitute for crunching the numbers. The decision as to whether it is better to pay the ‘Section 455’ tax or clear a director’s overdrawn loan account will depend on each director’s personal circumstances.

Talk to us we’re here to help you through the tax maze.