In a personal or family company the director will often borrow money from the company. This can be an easy source of finance, and also one that can be tax efficient as, if you time it correctly, it is possible to borrow up to £10,000 for up to 21 months tax-free. However, there are tax consequences if 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 on which corporation tax for the period is due and, in addition to any corporation tax due for the period, the company must pay ‘Section 455’ tax on the outstanding director’s loan balance.
Rate of ‘Section 455’ tax
Section 455 tax is aligned with the dividend upper rate. From 6 April 2016 to 5 April 2022 the rate is 32.5%.
As part of a package of measures to raise funds for health and adult social care, the dividend tax rates are increased by 1.25% from 6 April 2022. As a result, the rate of Section 455 tax will rise to 33.75% from that date.
Prior to 6 April 2016, the rate of Section 455 tax was 25%.
Which loan to repay?
Unlike other forms of tax, Section 455 tax is a temporary tax, which is repaid after the outstanding loan has been cleared. A repayment can be claimed from nine months and one day after the end of the accounting period in which the loan balance was cleared. This may be done in various ways, for example, by introducing funds from outside the company, declaring a dividend or by setting a bonus or salary payment against the loan.
If the director has several loans which are outstanding, it makes sense to clear those loans which attract a higher rate of Section 455 tax first.
The optimal repayment order is as follows:
- Loans made on or after 6 April 2022 (for which the rate of tax is 33.75%).
- Loans made between 6 April 2016 and 5 April 2022.
- Loans made before 6 April 2016.
Andy is a director of his family company A Ltd. He prepares accounts to 30 April each year.
In July 2015 he took a loan £20,000 from A Ltd. The company paid Section 455 tax of £5,000 (25% of £20,000) on 1 February 2016.
He took a further loan of £15,000 in May 2018 on which the company paid section 455 tax of £4,875 (£15,000 @ 32.5%) on 1 February 2020.
Andy is having building work done in April 2022 and plans to take a further loan of £25,000 on 20 April 2022. If he does not clear the loan by 1 February 2023, the company will have to pay Section 455 tax of £8,437.50 (£25,000 @ 33.75%).
He has an endowment policy that will mature in August 2022, the proceeds of which are £50,000. He plans to use this to clear the loans. To make the best use of this money to secure the maximum tax savings/repayments, he should clear the loans as follows:
- Loan of £25,000 made in April 2022. This will save the company tax of £8,437.50.
- Loan of £15,000 made in May 2018 This will generate a repayment of £4,875 on 1 February 2023.
- £10,000 of the £20,000 loan made in July 2015. This will generate a repayment of £2,500 on 1 February 2023.
Using the £50,000 in this way will save tax/generate repayments of £15,812.50.
Had he cleared the loans in chronological order, he would have received a repayment of £5,000 in respect of the 2015 loan and a repayment of £4,875 in respect of the 2018 loan. He would only have been able to clear £15,000 of the 2022 loan (saving Section 455 tax of £5,062.50). The total tax savings/repayment would be £14,937.50. He would also need to pay Section 455 tax of £3,375 on 1 February 2023 (against which the repayment due to him of £9,475 could be set).
Ref: CTA 2010, ss. 455, 458.