Discover how Director Loan Accounts work and what Section 455 tax means for UK business owners. Learn key rules, repayment timelines, and tax implications.
Director Loan Account & Section 455 Explained: A Guide for UK Business Owners
If you’re a director of a limited company in the UK, understanding the rules around Director Loan Accounts and Section 455 tax is crucial. These rules apply when directors borrow money from their company or leave money in the business. This blog will break down what a Director Loan Account (DLA) is, how Section 455 tax works, and what you need to know to avoid penalties.
What Is a Director Loan Account?
A Director Loan Account (DLA) records money borrowed by a director from their company or money they lend to the company. It’s separate from your salary, dividends, or other payments from the business. Essentially, if you take more money out of the company than you’ve put in, it’s considered a loan.
Types of Director Loan Accounts
1. Overdrawn Director Loan Account
An overdrawn DLA occurs when a director takes out more money from the company than they’ve contributed. This effectively means the company is lending you money. HMRC closely monitors overdrawn DLAs to ensure they are properly taxed or repaid.
Example:
If you’ve taken £10,000 from the company, but only paid in £3,000, you have an overdrawn balance of £7,000.
2. Credit Director Loan Account
If you lend money to the company, the account will be in credit. This can happen if, for example, you put personal funds into the business to cover cash flow. The company will owe you this amount, and you can withdraw it at any time without any tax consequences.
Example:
You loan £5,000 to your company for a project. The company now owes you £5,000, and this can be repaid without tax implications.
What Is Section 455 Tax?
Section 455 tax is a tax charge that applies when a director’s loan isn’t repaid to the company within a certain time frame. If your Director Loan Account remains overdrawn after the company’s year-end, and the loan isn’t repaid within 9 months and 1 day, the company must pay 32.5% Section 455 tax on the outstanding amount.
How Section 455 Tax Works?
- If you repay the loan within 9 months and 1 day of the company’s year-end, no Section 455 tax is due.
- If the loan isn’t repaid in time, the company must pay 32.5% of the outstanding loan as Section 455 tax.
- Once the loan is repaid, the company can claim back the Section 455 tax from HMRC.
Example of Section 455 Tax
Scenario:
- Company year-end: 31 March 2024
- Overdrawn Director Loan Account: £10,000
- Repayment deadline: 1 January 2025 (9 months and 1 day after year-end)
If the £10,000 loan is not repaid by 1 January 2025, the company must pay 32.5% of £10,000, which is £3,250, as Section 455 tax.
Once the loan is repaid in full, the company can claim back the £3,250 from HMRC. However, this can only be claimed after the end of the accounting period in which the loan is repaid, and it can take several months to get a refund.
Interest on Director Loans
HMRC expects companies to charge interest on loans to directors. If the company does not charge interest or charges less than HMRC’s official interest rate (currently 2.25% for 2023-24), the director may have to pay benefit-in-kind tax on the loan.
Personal Tax for Directors
If you borrow more than £10,000 from the company at any time during the year, you’ll need to declare this on your Self Assessment tax return as it counts as a benefit in kind. You’ll be taxed on the value of the benefit, usually the interest that would have been due on the loan.
Repaying a Director Loan
If you repay the director loan within 9 months and 1 day of the company’s year-end, you can avoid Section 455 tax. Repayments can be made in several ways:
- Direct repayment: Simply pay the company back the amount you owe.
- Salary or dividend: If you take a dividend or increase your salary to cover the loan, you can use these payments to clear the loan balance. Keep in mind that salary and dividends are taxable income, so you’ll need to account for tax on those payments.
Avoiding “Bed and Breakfasting”
HMRC doesn’t allow a practice known as “bed and breakfasting”, where a director repays a loan just before the 9-month deadline and then immediately takes out another loan after the deadline. To avoid penalties, you must wait 30 days between repaying and borrowing again.
Conclusion
Managing a Director Loan Account correctly is essential to avoid unexpected tax charges, especially Section 455 tax. Always track how much you borrow from your company and make sure to repay any loans within 9 months of the company’s year-end. If you find yourself with an overdrawn DLA, plan your repayments carefully to avoid unnecessary costs.
Key Takeaways:
- Director Loan Account (DLA): A record of money borrowed or loaned between a director and the company.
- Section 455 tax: A 32.5% tax on overdrawn loans not repaid within 9 months of the company’s year-end.
- Personal tax implications: Large loans may trigger benefit-in-kind tax on your Self Assessment return.
To avoid penalties and manage your DLA effectively, consult a tax professional for tailored advice.
Understanding how your Director Loan Account works will help you stay on top of your company finances and reduce the risk of tax surprises. By following the rules and repayment timelines, you can manage your loans efficiently and avoid Section 455 tax charges.
FAAS Accountants can help you manage Director Loan Accounts and ensure compliance with Section 455 tax rules, while maximizing tax efficiency.