There are many planning opportunities and pitfalls associated with the use of directors’ loan accounts. The following passage from our popular tax report Directors’ Loan Accounts Explained examines the method of introducing funds.
The simplest way to clear an overdrawn director’s loan account is to introduce funds into the company.
If the director is anticipating funds but needs money in the meantime, borrowing from the company can offer a cheap and easy source of bridging finance. If the loan is cleared before the section 455 trigger date, there is no tax to pay on the loan, other than any benefit in kind charge that might arise if the outstanding loan balance exceeds £10,000 at any point in the tax year (see Section 7 for further details of the potential benefit-in-kind charge).
Introducing funds allows the loan to be cleared without triggering associated tax or National Insurance liabilities and, depending on when the funds are introduced, will either prevent a section 455 charge from arising or trigger a repayment of section 455 tax previously paid.
Example 14: Introducing Funds To Clear And Overdrawn Director’s Loan Account
Jackie is the director and sole shareholder of her personal company. The company prepares accounts to 31 March each year.
Jackie has a bond for £15,000 that is due to mature on 30 June 2018. However, she wishes to upgrade her kitchen in February 2018, so she borrows £15,000 from the company. She repays the loan on 15 July 2018 once the bond has matured.
As the loan is outstanding at the 31 March 2018 year end, Jackie will need to declare the details on her company tax return. However, as it has been repaid before 1 January 2019 (the section 455 trigger date), there is no section 455 tax to pay on the loan.
Although there will be a benefits in kind charge to pay on the loan (see Section 7), there is no further tax to pay as a result of Jackie introducing her own funds to the company to clear the loan balance.
Jackie is able to enjoy a low-cost loan from her company to enable her to undertake her kitchen improvements before the bond has matured. Borrowing the money and using private funds to repay it at a later date is more tax effective than drawing the money from the company in the form of a bonus or a dividend.
When anticipating a payment of funds, borrowing from the company to tide oneself over in the meantime or to fund a particular project ahead of receiving the funds can be more tax- efficient that withdrawing money from the company as a salary payment, bonus or dividend. This is particularly the case if the loan can be cleared ahead of the trigger date for the section 455 charge (nine months and one day after the end of the accounting period in which the loan was made).
Where private funds are available, this can be an easy and cost-effective way of clearing an overdrawn director’s loan account.