It is common for transactions to take place between a director and their family or personal company while a director’s loan is an account that is used to record transactions that take place between both.
However, if it becomes apparent that there is money owed by the director to the company and the loan continues to remain unpaid for nine months and one day following the end of the accounting period it was made, then there will be tax consequences. This date is when corporation tax is due and will cover a certain period. When this occurs, the company will be expected to pay tax on the overdrawn balance which will equate to 32.5% of the amount.
Section 455 Tax Charge and How to Avoid it
If the loan amount is paid prior to the due date for corporation tax, then it is possible to avoid a Section 455 charge. Despite this, there are anti-avoidance rules that become applicable and so, you should make sure that you do not fall on the wrong side of these rules. The rules are designed to make sure that genuine payments are made as opposed to transactions that are made simply to get around the Section 455 charge.
The 30-Day Rule
This rule comes into effect within 30 days of when the amount repaid is more than £5,000 and the participator makes the decision to borrow from the company again. As a result, Section 455 tax will have to be paid on the smaller amount of the loan that is repaid and the amount that they have borrowed again. What this means is that the repayment is considered to be ineffective to the point where the funds are borrowed again within 30 days.
Regardless of which comes first, whether it’s the additional borrowing or the loan repayment, the 30-day rule applies. This stops a participator from obtaining a new loan and using that to pay back part of the original loan or all of it.
The Intentions and Arrangement Rule
This rule provides the taxman with another opportunity to explore the situation again where the 30-day rule does not come into effect as a result of the period between both the repayment and the new loan exceeds 30 days. With this rule comes a motive test and it has the potential to capture repayments and additional borrowing that takes place more than 30 days apart where the sole aim is to avoid paying tax.
This rule becomes applicable when the loan amount that is outstanding immediately prior to repayment is a minimum of £15,000 and, at the time when the repayment takes place, there are arrangements in place or intention to borrow an additional £5,000 or more.
Even if the new borrowing is beyond the 30 days, this rule becomes applicable. It also comes into play should the repayment be made with the intention of taking a minimum of £5,000 of the payment, regardless of when this takes place. What this means is that taking the approach to wait 31 days before obtaining more funds will not work.
However, this rule is not applicable to funds that are taken as a dividend, bonus or salary as they are within the boundaries of income tax.
It’s possible to avoid a Section 455 charge by paying an outstanding loan balance by using a dividend, bonus or salary as they have their own tax charges applied to them while it is possible to use external funds to make a payment that is genuine.