Understanding s455 tax: Navigate the rules for company directors’ loans
Facing a tax charge for a director’s loan?
In case you’re not aware, a director’s loan is when a company director borrows money from the company for personal use, separate from their salary, dividends, or business expenses. s455 tax issues arise when company directors don’t repay their loans on time.
This guide unpacks the s455 tax implications to ensure you understand your liabilities and how to stay compliant. Steer clear of the common pitfalls with our in-depth analysis of the s455 tax rules and consequences.
Overview:
- Understanding s455 tax
- The Corporation Tax connection
- Key factors affecting s455 tax
- Strategies for managing s455 tax
- Tax implications of non-compliance
- Record keeping and administration
- Tax implications of non-compliance
- Record keeping and administration
- Closing or insolvency: The impact on s455 tax
- Dealing with multiple director’s loans
Understanding s455 tax
The s455 tax, named after its designated section in the Corporation Tax Act, applies when a director borrows money from their business and fails to repay the full amount within a specified time period.
This tax is predominantly relevant to close companies, typically controlled by five or fewer shareholders.
Borrowing from your own business carries complex tax implications, particularly concerning the repayment timing and amount.
The implementation of the s455 tax falls under a broader legislative framework aiming to hold company directors accountable for their financial transactions. Its existence serves a very specific purpose in Corporation Tax, which we will explore next.
The purpose of s455 tax
The s455 tax was introduced to deter companies from advancing their directors’ interest-free loans without a set timeframe for repayment.
Essentially, it’s a mechanism to discourage the use of company funds for personal purposes without incurring tax obligations.
However, the purpose of the s455 tax extends beyond simple deterrence. It aims to equalise the tax treatment of directors’ loans with other forms of profit extraction, such as dividends, to ensure a fair tax system.
This legislation is designed to prevent close companies from issuing loans to participants without corresponding tax consequences.
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The Corporation Tax connection
The s455 tax has an inherent connection to Corporation Tax. It is due alongside Corporation Tax, precisely nine months and one day from the close of the current accounting period.
What if the director’s loan is repaid, written off, or released?
In such cases, the company can claim a refund for the s455 tax paid. However, there’s a catch. The repayment or write-off must occur within four years from the end of the financial year in which the repayment took place.
Notably, the rate of s455 tax on loans to participants increased from 32.5% to 33.75% effective April 6, 2022.
Key factors affecting s455 tax
Several key elements can influence the implementation of the s455 tax. These include the timelines for loan repayment, outstanding loans balances, and the shareholding status of the director.
Each of these factors has specific implications for the tax charge, which we explore in the following sections.
Several key elements can influence the implementation of the s455 tax.
These include the timelines for loan repayment, outstanding loans balances, and the shareholding status of the director.
Loan repayment timelines
The timeline for loan repayment is one of the significant elements influencing the s455 tax.
If a director’s loan account is overdrawn and not cleared after the specified timeline post-accounting year-end, then the s455 tax must be paid. This timeline is nine months and one day after the end of the accounting year.
The tax rate for loans taken out before April 6, 2022, is 32.5%. After April 6th, 2022, loans made are taxed at a rate of 33.75% of the outstanding loan value at the nine-month and one-day deadline.
However, loan relief can be claimed 9 months and 1 day post the end of the accounting period when the loan is repaid.
Outstanding loan balances
The outstanding loan balance is another pivotal factor.
If a director’s loan is more than £10,000, and the director takes another director’s loan of £5,000 or more within 30 days before or after repaying the first loan, the company must pay a corporation tax charge at 33.75% of the original loan value.
Moreover, if a loan exceeds £10,000 at any point during the tax year, the company must also account for Class 1A National Insurance at 13.8% on the taxable amount of the loan, which contributes to the employee’s employment income.
Shareholding status
The shareholding status of a director also impacts the s455 tax.
This tax applies to loans or advances made by a company to its participants, which include shareholders, or to any associates of these participants.
So, loans given to family members like spouses, parents, or children of shareholders are regarded as loans to associates and are thus subject to s455 tax.
It’s important to note that s455 tax targets shareholders regardless of whether they hold positions as directors or employees in the company.
Moreover, the tax consequences for a director’s loan can vary if the director is also a shareholder, as the option to declare dividends to counterbalance the loan may exist.
Strategies for managing s455 tax
Strategic planning is required to navigate the complexities of the s455 tax. Directors may use personal financial resources to repay the loans.
Another strategy is to clear an overdrawn director’s loan account by declaring a dividend or paying a bonus. However, directors should be aware that these options could result in a personal tax liability, and the company must be profitable for dividends to be declared.
Being strategic about the timing of loans can also minimise the s455 tax. For instance, loans taken before an increase in the tax rate are subject to a lower rate, making early repayment beneficial before such changes.
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Tax implications of non-compliance
Serious implications can arise from non-compliance with s455 tax rules. For loans made up to 5 April 2016, the rate of s455 tax was 25%, and for loans made on or after 6 April 2016, the rate is the dividend upper rate for the tax year, which was 32.5% from 2016-17 to 2021-22, and 33.75% for loans made on or after 6 April 2022.
A Section 455 tax charge arises when a director’s loan from a family or closely held company is not repaid by the Corporation Tax due date, and anti-avoidance measures exist to prevent cycling loans around this date to avoid the charge.
Non-compliance can lead to penalties, and interest on overdue s455 tax stops accruing only when the loan is repaid, released, or written off. This makes it crucial for directors to stay compliant with s455 tax regulations.
Record keeping and administration
To ensure accurate tax payments related to director’s loans, meticulous record-keeping is paramount. Director’s loans must be documented in a director’s loan account with details such as:
- Loan amount
- Interest rate
- Terms
- Repayment records
This is mandated by the Companies Act 2006 section 413.
For financial reporting, funds owed by and to directors should be recorded appropriately as:
- Debtors
- Creditors
- Provisions for formal offset arrangements
- Treatment of below-market interest as income.
Furthermore, companies must report any s455 liabilities and may reclaim any s455 tax paid on overdrawn accounts within a specified four-year timeframe after loan repayment.
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Closing or insolvency: The impact on s455 tax
Company closure or insolvency can have a severe impact on the s455 tax for directors. In approximately 80% of cases where a company becomes insolvent, directors have not repaid their overdrawn director’s loan account, leading to potentially serious financial and legal consequences.
Upon company liquidation, the liquidator may demand the director repay the loan amount owed, with potential actions including legal measures or pushing for the director’s bankruptcy.
In a creditors’ voluntary liquidation scenario, liquidators focus on recovering the outstanding director’s loan to distribute funds to creditors. Directors may even face accusations of wrongful trading if a winding-up petition reveals improper handling of an overdrawn directors’ loan account.
Dealing with multiple director’s loans
HMRC treats multiple director’s loan accounts separately for reporting and tax purposes, and may not combine accounts for tax unless evidence indicates an intent to form a combined loan account.
The presence of multiple loans can lead to tax charges on the entire amount if they are not all repaid timely.
Failing to repay one of multiple outstanding director’s loans may result in S455 tax charges on all outstanding loans. Therefore, handling multiple director’s loans requires:
- Careful consideration of separate accounts
- Timely repayment to avoid widespread s455 tax charges
- Thorough documentation to demonstrate individual loan intentions.
Summary
Understanding and managing the s455 tax can be a complex task for directors of close companies. From loan repayment timelines to outstanding balances and shareholding status, numerous factors can affect the application of this tax.
Strategic planning, accurate record-keeping, and professional advice are essential for successfully navigating this tax landscape. Failure to do so can result in severe financial and legal consequences.
It’s crucial, therefore, for directors to stay informed and take proactive measures to manage their s455 tax liabilities.
FAQs
You can avoid the s455 tax charge by ensuring that your director’s loan is cleared by the Corporation Tax due date, which is nine months and one day after the end of the accounting period.
You can reclaim your s455 tax by completing the CT600A supplementary pages while filing your Corporation Tax return, as long as it’s within nine months of the end of the relevant accounting period.
If it’s past that deadline, fill up the L2P form available on the “Reclaim tax paid by close companies” section of the government’s website.
The current rate for s455 is 33.75% of the outstanding loan balance, effective from 6 April 2022.
The S455 tax rate for 2024 is 33.75%
S455 tax is a corporation tax charged when a director of a company fails to return the full amount borrowed from their business within a specified time period. It primarily applies to close companies, typically controlled by five or fewer shareholders.
