Your company is facing a tax bill because your director’s loan account is in the red. Must you and your company accept the tax bill or is there a more tax-efficient alternative?
Loan-related tax charge
You probably know that if your company lends money to a participator (someone who owns or controls 5% or more of its ordinary share capital), any part of the debt that’s not repaid within nine months after the end of its financial year is liable to a special tax, known as an s.455 charge. The tax applies to the outstanding debt at 33.75%. Companies are entitled to a refund of the tax nine months and a day after the end of the financial period in which the debt is cleared.
Owner-managed companies
Companies owned and managed by one or a few individuals whose income is only or mainly derived from it should consider carefully whether to accept a s.455 charge or avoid it by ensuring any debts are cleared within the nine-month deadline. There’s more than one way to do this although each comes at a price in terms of cash flow.
Example 1. Ivan is a director and the sole shareholder of Acom Ltd. His only income is salary and dividends from Acom. Its financial year ends on 30 November. On 30 November 2024 Ivan owed Acom £18,000. Assuming none of this debt was cleared by 1 September 2025 Acom would be liable to a s.455 charge of £6,075 (£18,000 x 33.75%) payable on that date. Acom therefore declares and pays a dividend of £18,000 to Ivan which he uses to repay the debt before the September deadline. However, this isn’t good for Acom’s cash flow. It has paid out cash of £18,000 to save £6,075. What’s more, Ivan – as a basic rate taxpayer – will owe tax of £1,534 on the dividend, payable on 31 January 2027. There is a better alternative.
Example 2. On 31 August 2025 (or a little earlier) Acom declares a dividend of £19,534 which instead of paying to Ivan it credits against his £18,000 debt; this leaves him in credit to the tune of £1,534. Ivan can draw this excess on 31 January 2027 to pay the tax of £1,534 on the dividend. Until then it has cost Acom zero cash but it’s dodged the s.455 tax. Also, there’s no net cost to Ivan as his tax bill is covered by the £1,534 credit.
Tip. If Ivan needs to borrow again from Acom he can do so without having to worry about the so-called s.455 bed and breakfast rules. These don’t apply where a debt is cleared by this type of book entry.
S.455 v income tax
If Ivan was liable to higher rate tax instead of the basic rate, a dividend of £27,170 would be needed to clear the £18,000 debt and leave him enough in credit to cover the tax on the dividend of £9,170. That means the cash cost of covering Ivan’s income tax bill would be greater than the s.455 tax of £6,075. In these circumstances it would seem better for Acom to accept the s.455 charge, but there is a way to mitigate this.
Tip. Acom could credit Ivan with an £18,000 dividend to prevent the s.455 charge. His personal tax on this would be up to £6,075 (£18,000 x 33.75%) payable on 31 January 2027. At that time Acom could pay him a further dividend or lend him the cash to cover it.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.