Can business owners draw money out of a company through a loan?
We are often asked whether it is ok for owner-managers to draw money out of a company by way of loan rather than as dividends or salary. Whilst it is possible for owners to make use of company loans, as with any other area of tax the rules are not simple and overdrawn directors loan accounts can give rise to tax liabilities for both the director and the company.
If a director’s loan account exceeds £10,000 at any time during a tax year, then unless interest is paid on the loan at least at the HMRC official rate (currently 2.0%), a benefit in kind will arise. This must be reported on the director’s form P11D and self-assessment tax return and the company will have a Class 1A National Insurance liability. Note that the £10,000 rule applies to the aggregate of all loans to the individual outstanding in the year.
In addition, where directors loan accounts are overdrawn at the end of a company’s accounting period, a tax charge known as ‘section 455 tax’ can arise. This charge usually applies where the director whose loan account is overdrawn is also a shareholder of the company and the company has no more than five shareholders.
The tax rate for section 455 tax is the same as the dividend higher rate, which is currently 32.5%. This is set to increase to 33.75% from 6 April 2022.
Companies that are not required to pay their corporation tax by instalments are required to pay any section 455 tax due on their normal due date for payment of corporation tax, i.e. 9 months and 1 day following the end of the accounting period.
The tax is charged on the lower of:
- the amount of the loan outstanding on the last day of the accounting period; or
- the amount outstanding on the normal due date for payment of corporation tax.
Therefore if the loan is repaid in full within 9 months of the year-end, no section 455 tax would be payable. This means that it is possible for a shareholder to take out a loan from a company for up to 21 months, if the loan is taken out at the beginning of the company’s accounting period, without incurring a tax charge.
For example, if a company has a year end of 31 December and a shareholder takes out an interest free loan of any amount up to £10,000 on 1 January 2022, no tax charge will arise on the individual or on the company provided that the loan is repaid in full on or before 30 September 2023.
However if any amount of the loan is still outstanding 9 months and one day after the year-end, section 455 tax will be payable by the company. The tax paid will later be refunded to the company following the repayment or release of the loan. The procedure for claiming the repayment depends on the timing of the loan repayments and on the date that the company’s tax return is submitted.
Bed and breakfasting
Anti-avoidance rules exist to prevent the ‘bed and breakfasting’ of loans. This is typically where a loan to a shareholder is repaid to the company shortly before the date on which the section 455 tax becomes due and then the same or a similar amount is loaned again to the same individual in the following accounting period.
The anti-avoidance rules apply where either:
- within a 30-day period, a shareholder makes repayments to the company in excess of £5,000 and in a subsequent accounting period, new loans or benefits in excess of £5,000 are made to the same person or their associate; or
- where the total amount of a shareholder’s loan exceeds £15,000, arrangements had been made for new borrowings in excess of £5,000 to be made to replace some or all of the amounts repaid.
The bed and breakfasting rules do not apply where the loan repayments are made out of taxable salary and/or dividends paid to the individual.
In order to maximise the cash flow advantages and to minimise the tax payable on loans made to shareholders, it is important to get the timing right for both the advance and the repayment of loans.