When a director borrows money from their company and does not repay it within the designated time frame, the loan becomes overdrawn. The tax implications of such a scenario are significant, especially when it triggers a Section 455 (S455) tax charge. This article explains how an overdrawn director’s loan works, how the S455 tax is applied, and what business owners or directors can do to avoid unnecessary tax costs.
What is a Director’s Loan Account?
A Director’s Loan Account (DLA) tracks the financial transactions between a company and its directors. When a director either lends money to the company or withdraws money from it, these transactions are recorded in the DLA. It is important to note that a director’s loan is neither a salary nor a dividend; instead, it is a temporary arrangement for borrowing or lending money to the company, typically to cover personal or business expenses. Accurate record-keeping of these transactions is essential to avoid potential tax issues and to ensure transparency in financial dealings.
When is a Director’s Loan Account Overdrawn?
A Director’s Loan Account becomes overdrawn when the director takes out more money from the company than they have put in or have available as a loan balance. This means that the director owes the company money. The loan account is then considered “in debit,” indicating a negative balance. This situation can arise when the director withdraws funds for personal use or any other purpose without having enough funds in the account to cover the withdrawal.
How S455 Tax Applies to Overdrawn Loans
S455 tax applies when a director’s loan account is overdrawn at the end of the company’s financial year. The tax, calculated at a rate of 33.75% (for the 2024-25 tax year), is levied on the outstanding loan balance. If the loan was made before April 6, 2022, a lower rate of 32.5% applies. This charge is meant to discourage directors from borrowing large sums from their companies, especially on an interest-free or low-interest basis. If the loan is not repaid within nine months and one day from the end of the accounting period, the S455 tax becomes due. The company must report this in its corporation tax return (CT600). However, the tax is not a permanent charge; once the loan is repaid, the company can reclaim the S455 tax.
Additionally, if the loan exceeds £10,000, it is classified as a benefit in kind, requiring the company to report it on a P11D form. The director must pay personal tax on this benefit unless interest is paid at or above HMRC’s official interest rate, currently set at 2.25%. The company will also have to pay Class 1A National Insurance contributions on the BiK at a rate of 13.8% for the 2024-25 tax year, increasing to 15% from 2025-26 on the loan.
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To avoid or mitigate S455 tax liability, directors should aim to repay any outstanding loan amounts within nine months and one day after the end of the company’s accounting period. If the loan is fully repaid within this timeframe, the S455 tax charge does not arise.
If the director is also an employee, and the loan exceeds £10,000, it may be classified as a benefit in kind (BiK), triggering additional tax obligations. The company would need to report it on a P11D form and pay Class 1A National Insurance (13.8% for 2024-25, increasing to 15% in 2025-26), while the director would be liable for income tax on the benefit through self-assessment.
Another option is to write off the loan, but this has tax consequences. The company would not face a corporation tax charge, however the director would have to pay income tax on the written-off amount, as it would be treated as additional remuneration. Seeking tax advice before choosing this route is essential.
To effectively manage and mitigate S455 tax exposure, directors should monitor loan balances and plan repayments accordingly. Structuring salary, dividends, or bonuses to facilitate timely repayment can help avoid unnecessary tax liabilities.
What to Do if Your Director’s Loan Account is Overdrawn
If your Director’s Loan Account is overdrawn, there are several steps to take to resolve the situation:
- Repay the loan as soon as possible to avoid the S455 tax charge.
- Declare a dividend (if your company is profitable and you are a shareholder) to offset the amount owed. However, this will have its own tax implications.
- Convert the loan into salary or bonus, though this will be subject to PAYE tax and National Insurance contributions.
- Write off the loan if repayment is not feasible, but be prepared for personal tax liabilities.
- Seek professional tax advice to explore the most tax-efficient solution based on your company’s situation.
An overdrawn Director’s Loan Account can result in significant tax consequences, particularly under Section 455. It’s important for directors to monitor their loan accounts carefully and ensure that any balances are repaid on time to avoid unnecessary tax charges. Business owners can manage their finances better and be compliant with tax laws by understanding the S455 tax and taking the right actions. If you find yourself in an overdrawn situation, seeking expert advice is always recommended to find the most tax-efficient solution.
