Generally speaking, loans from owner-managed limited companies are taken out by the director-shareholders in three major situations:
- Funds are required for use by the director-shareholder for a short term purpose.
- A director-shareholder is completely unaware of what funds in the company bank account is required for tax purposes (e.g. corporation tax and VAT) and what funds are available to be paid out as dividends. Consequently, director-shareholders inadvertently pay out company tax reserves to themselves as ‘illegal’ dividends.
- A director-shareholder uses company funds to pay for private expenditure.
The emergency coronavirus pandemic is likely to result in an increase in the frequency of situations 1 and 3 occurring as a potential global economic recession looms, contracts becomes more difficult to obtain due to the spectre of off payroll, a lack of income support from the Government for limited company director-shareholders creates pressure on director-shareholder’s personal finances, etc which forces director-shareholders to borrow company money.
In addition, company funds will be easier to borrow by director-shareholders given that the Government, in response to the emergency coronavirus pandemic, is allowing businesses to defer VAT payments due between 20 March 2020 to 30 June 2020 until 31 March 2021. Furthermore the Government has also created a Coronavirus (COVID-19) helpline to support businesses who need to arrange a payment plan for their company’s tax bill.
Consequently, if you do need to borrow money from your company, here are a few things to bear in mind from a tax point of view:
- If the loan exceeds £10,000 at any point in the tax year a benefit-in-kind tax charge or interest charge will be due from the director to their limited company at a rate of 2.5% per annum on a pro rata basis. The interest received by the company would be subject to corporation tax (19%) and the balance would form part of the company’s reserves and would be available for extraction from the company, e.g. as dividends. In many cases, a benefit-in-kind tax charge or interest charge is a small price to pay for being able to access your company’s funds at 2.5% on a short term basis (compared with taking a commercial loan).
- If the loan is not repaid within 9 months and 1 day of the end of the corporation tax period in which the loan was taken out then a temporary tax called Section 455 corporation tax is due on the outstanding loan balance.
- This temporary Section 455 corporation tax (32.5%) on an outstanding loan balance is repayable back to the limited company by HMRC 9 months after the end of corporation tax period in which the loan was repaid. This is what makes this Section 455 tax temporary or refundable.
- HMRC can request a breakdown of the director’s loan account, e.g. a list of the date, description and amount of every transaction passing in and out of the director’s loan account. I have seen this in practice and penalties can become due if the taxpayer has not kept the proper records. Although if you use FreeAgent the software maintains a director’s loan account schedule ready should HMRC investigate.
- A director’s loan account can be repaid by crediting a dividend to the loan account however this is not always tax efficient if the rate of tax due on the dividend is greater than the rate of the temporary Section 455 tax which is currently 32.5%. Dividend tax rates can easily exceed 32.5% if the dividend triggers a high income child benefit tax charge, a restriction of the tax payer’s personal allowance or triggers additional rate tax. Therefore in some situations paying the temporary Section 455 tax can end up being the cheaper option, especially when you take into account that income tax on dividends is not temporary/refundable.
- HMRC have also confirmed in their corporation tax guidance that overdrawn director loan accounts can be distributed to shareholders on liquidation and can qualify for the 10% entrepreneur’s relief tax rate and can trigger a repayment of any Section 455 corporation tax paid in respect of the loan.
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The above information is just for guidance purposes only and is not a substitute for professional advice and consulting the legislation.