In this case study, we take a look at the effect for both the company and an individual shareholder across various stages of its lifecycle and the consequences, positive and negative of a Directors loan account in credit and in debit.

 

Company Background

Mrs Shaw set up her company selling dolphin translation devices in January 2022, following a generous Christmas gift from Aunty Gibbs, you know, one of those cards with a pound coin taped inside.  The company’s first period ran through to 31 December 2022.

 

Loan in Credit

She set up the company bank account and loaned all £3 of her Christmas money to the company, this gave Mrs Shaw a ‘credit loan account’.

In the majority of cases, the credit loan account is held interest free, with renumeration coming in the more traditional forms of salary and dividends.  However, it would be worthwhile these business owners considering the most tax efficient way of extracting funds, and interest could be part of the solution.

Interest, at a reasonable commercial rate, can be charged by the individual to the company.  Depending on that individual’s personal tax position (and other savings income), they may have a £1,000 or £500 0% tax band available against this income, with the rest taxed at their marginal income tax rate – this marginal rate is likely to be higher than dividends, but, importantly, is tax deductible for the company.  Therefore, potentially, tax deductible income of £1,000 (or more if the personal savings rate is available) could be drawn from the company, without any tax arising on the individual.

The company has to complete quarterly forms (forms CT61) to report the amounts paid, whilst withholding 20% tax which is payable to HMRC.

For Mrs Shaw, in those good old days, where the company owed her money, she charged the company interest at a reasonable commercial rate on her credit balance.  The gross income was reportable on Mrs Shaw’s personal tax return, along with the accompanying tax credit.  However, as a basic rate taxpayer (the dolphin translation business had not taken off yet), she benefited from a £1,000 0% personal savings rate, which covered the interest paid and allowed her to reclaim the tax the company deducted.

 

Close Company

The following section on overdrawn loans only applies to Close Companies, such as Mrs Shaw’s.

 

Loan Overdrawn

In the second year of trade, the year to 31 December 2023, Mrs Shaw was going through some renovation works at her home.  Her personal funds were low, so she put some of the building costs onto the company card.  The total was more than the £3 the company owed her, such that she took the balance to the point she owed the company £20,000.  As at the year-end, 31 December 2023, this balance remained at £20,000.

As it was relatively easy for the business owner to create a credit loan account, it is also very easy to create a debit loan account, such that the individual has drawn more from the company account than they were actually owed.

Where the loan account goes overdrawn in an accounting period, and remains overdrawn at the end of that accounting period, and is still overdrawn 9 months and 1 day after the end of that accounting period, the company will be subject to a tax charge (known as a s455 charge).  This charge differs to the ‘normal’ corporation tax rates, and instead, matches the higher rate charge of dividends taxed on an individual.

In January 2024, Mrs Shaw turned 40 (that bit is not really relevant), and her Aunty, Aunty Gibbs, generously taped £5,000 to the inside of her birthday card, she used this to pay back some of the money that she owed the company.  The balance of £15,000 overdrawn remained through to 31 October 2024.

This was a close company (as mentioned above) and as there was an outstanding balance debit balance on the loan at 9 months and 1 day after the end of the 31 December 2023 accounting period (1 October 2024), and only £5,000 had been repaid before that date, the company suffered a s455 tax charge at 33.75%, so £5,062.50 was payable with the company’s normal corporation tax bill.

Christmas 2024 came around, and Aunty Gibbs gave Mrs Shaw a further £15,000 (what an Aunty she is!), which she paid to the company on 26 December 2024.  Mrs Shaw knew if she cleared the loan in the accounting period to 31 December 2024, then the s455 charge which she suffered on 1 October 2024 would be repaid to her on 1 October 2025, that date being 9 months and 1 day after the accounting period in which the loan was repaid.

When the loan is repaid, this s455 charge will be repaid to the company, so it is only a temporary charge on the company, providing they will clear the loan debit loan in the future.  There is, however, a timing delay before the charge becomes repayable.

 

Bed and Breakfasting

However, Mrs Shaw wanted to celebrate being 41 years old and booked  a big holiday, once again, she had to use the company card, and borrowed a further £10,000. This happened on 15 January 2025, i.e., she borrowed more money within 30 days of the last repayment.

Special provisions have been put in place to prevent a participator clearing a loan temporarily to avoid paying a s455 charge, but withdrawing a ‘new’ loan, which is essentially the same as the old loan shortly after.  Without the provision, loans could remain almost indefinitely without a charge to the company.

The result of this holiday essentially means that £10,000 of that £15,000 repaid on Boxing day is matched to this latest withdrawal.  When we look at the position for the year ended 31 December 2024, she has effectively only repaid £5,000 of the loan.  1 October 2025 comes around, and the company will be due to get s455 of £1,687.50 back, being 33.75% of the £5,000 repaid.

 

Clearing the Loan

By November 2025, Mrs Shaw has saved up enough of her salary and dividends to repay the remaining £10,000 that she owed the company.  At this point, the home improvements were complete, no more big holidays were planned, and she does not need to borrow any more money from the company.  The loan has been cleared in the accounting period ending 31 December 2025, no further amounts are withdrawn, the company will be due the remainder of the s455 paid back in October 2024 (£3,375 being £10,000 @ 33.75%) on 1 October 2026, i.e., 9 months and 1 day after the end of the accounting period the loan was repaid.

 

Benefits in Kind

In the times where the loan from the company exceeded £10,000 running from 6^th of one month to 5^th of the next, if the loan was interest free or below market rate, a taxable benefit in kind will arise.  Which will need reporting on a form P11D, the employee/Director will pay tax at their marginal rate, and the company will have a Class 1A NI charge (currently at a rate of 15%).

 

Next Steps

If you are running a company and you feel any of these issues are a concern for you or that you could simply benefit from a discussion of the topics raised in more depth please reach out to your usual contact at Shaw Gibbs.

We will be able to assist you with completing the forms CT61, forms P11D accordingly, and be able to assist with reclaiming historic s455 tax paid once repayments have been made on the overdrawn loan account.