Tax Insider Reports: Meaning of Loans

5th Jun 2019
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A director’s loan account is a mechanism of keeping track of the transactions between the director and his or her personal or family company. Reasons that this will be done are varied but includes:

  • Borrowing money from the company can be a cheap source of finance.
  • Tax consequences may arise if the account is overdrawn.
  • Interest can be paid if the account is in credit.

Transactions between a director and his or her personal or family company are common and a director’s loan account is simply an account for recording the transactions that occur between the two.

The following is an excerpt from our best-selling business tax report Directors’ Loan Accounts Explained.

Meaning Of ‘Loan’

When looking at the rules that apply in relation to loans to directors and participators in close companies, it is important to understand what is meant by the term ‘loan’. For these purposes, a loan is much wider than a formal loan from the company to the director or participator. A loan can arise as a result of using company funds for private expenses or because the company pays a personal bill on the director’s behalf. The director may regard the company’s money as effectively his own and may not even be aware that he has created a ‘loan’.

Example: Meaning Of ‘Loan’

Mary is a director in her family company, which is a close company. She wishes to take her family on a holiday, the cost of which is £6,000. She pays for the holiday using the company credit card.

This will create a loan to Mary from the company. If this is not cleared, it may trigger a section 455 tax charge.

There is no formal loan or loan agreement, but nevertheless, a loan has been created.

The legislation extends the meaning of loan to situations in where a director/participator incurs a debt to the close company or where a debt is due from the director/participator to a third party and that debt is assigned to a close company.

Anti-avoidance provisions apply to bring certain loans to partnerships in which the participator is a partner within the scope of the tax charge (see Section 9).

What Is Not A Loan?

Certain debts owed by the director to the company do not count as a ‘loan’ for these purposes.

Unpaid Share Capital

Unpaid share capital, although money owing to the company, does not count as a loan for these purposes. This view was confirmed by the First-Tier Tribunal in RKW Ltd v HMRC TC (2011) 05945, who found that a section 455 charge should not apply to the debt.

Supply Of Goods And Services

The section 455 charge does not apply to a debt that relates to a supply of goods and services by the company in the ordinary course of its trade or business unless the credit period exceeds six months or is longer than that normally given to the company’s customers.

Small Loans

Small loans are outside the scope of the section 455 charge. A small loan is one that is made to a director or employee of the close company or an associated company, in respect of which all of the following conditions are met.

Condition A is that the amount of the loan or advance does not exceed £15,000 either alone or when taken together with any other outstanding loans and advances which were made to the borrower by the close company or by any of its associated companies. In deciding if the value of the outstanding loans is less than £15,000, loans to a spouse or civil partner are not taken into account. For the purposes of this test, each spouse or civil partner has their own £15,000 limit.

Condition B is the borrower works full-time for the close company or any of its associated companies. An employee is regarded as working full-time if they work for at least three-quarters of the normal working hours of the close company.

Condition C is that the borrower does not have a material interest in the close company or any of its associates. In the event that the borrower acquires a material interest at a time when the whole or part of any loan is outstanding, the company is treated as making a loan to the borrower of the amount of the loan as is outstanding at the time that the person acquires a material interest.

The material interest test is met if one of the following conditions is met:

  • the person (with or without one or more associates), or any associate (with or without one or more associates) is the beneficial owner or directly or indirectly is able to control more than 5% of the ordinary share capital of the company; or
  • in the case of a close company, a person (alone or with one or more associates) or any associate (alone or with one or more associates) possesses or is entitled to acquire such rights as would in the event of winding up of the company or in any other circumstance give entitlement to receive more than 5% of the assets which would then be available for distribution among participators.


When applying the small loans test, the effect of cumulative small loans should not be overlooked. Where a participator receives several small loans over a period, the aggregate amount outstanding may eventually exceed £15,000. It should be noted that where the £15,000 limit is breached, it is not just the excess that is with the scope of the charge; rather, the whole amount of the loan taking the aggregate amount outstanding is subject to the section 455 charge.

Example: Small Loans

In year 1, a director of a close company receives a loan of £4,000. The director is a full-time working director and he does not have a material interest in the company.

The loan of £4,000 is within the small loans limit. In year 2, he receives a further loan of £5,000. The aggregate outstanding at the end of year 2 is £9,000. The new loan of £5,000 is also within the small loans limit.

In year 3, the director receives a further loan of £8,000. The total outstanding at the end of year 3 is £17,000. This exceeds the small loan limit. However, the full amount of the year 3 loan (£8,000) is within the section 455 charge, not just the excess over £15,000 (i.e. £2,000). The small loans exemption does not apply to the loan of £8,000 as the aggregate balance outstanding is more than £15,000.

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