Understanding the tax risks of overdrawn directors’ loan accounts

If you're a director, shareholder, or closely related party in a company, having an overdrawn loan account by the end of the financial year could lead to additional tax liabilities you may not have anticipated.

Commonly known as Section 455 (S455) tax, this could considerably impact your company's finances.

Below is a simple overview of the implications and responsibilities that come with overdrawn loan accounts:

What is S455 Tax?

If a director withdraws money from the company, thereby owing money back, S455 tax is applied to the loan account balance.

This tax applies at a rate of 33.75 per cent of the overdrawn balance at the close of your Corporation Tax accounting period. While it mimics dividend tax rates, it's crucial to understand that this tax is only temporary, provided balances are promptly repaid.

Your tax obligations may become more complicated if the loan exceeds £10,000 or if you've paid interest to the company below the official rate.

In such instances, the loan is treated as a 'benefit in kind,' and Class 1A National Insurance must be deducted. The director is also obliged to report the loan on a personal Self-assessment tax return.

Repaying the loan

If the loan is repaid within nine months of the end of the accounting period, you may avoid paying S455 tax.

However, you're still required to declare it on form CT600A when preparing your company tax return. If repayment does not occur within this nine-month window, the S455 tax becomes payable to HMRC.

Be aware that temporarily repaying the loan within nine months only to redraw the same or larger amount shortly after is not considered a genuine repayment.

Reclaiming S455 tax

A reclaim can only be initiated nine months after the accounting period in which the loan was finally repaid.

You must also reclaim within four years of the loan repayment, or you will lose the entitlement to do so. Use form CT600A if reclaiming within two years of the end of the accounting period when the loan was initiated; otherwise, complete form L2P.

Navigating the complexity of directors’ loans

Given the intricate nature of these regulations, it is crucial to maintain accurate records and consult financial advisors or tax professionals to mitigate the risk of accruing additional liabilities. Don't underestimate the importance of staying on top of what you owe to HMRC and what is recoverable.

Contact our team for advice on meeting your tax obligations.