Sam Hart looks at the tax implications and timing issues with directors loan accounts.
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Many owner-managed businesses will have a director’s loan account (DLA) on their balance sheet. For advisers who work with entrepreneurial clients, it is important to understand how these balances arise, how they can be cleared and how the various tax charges operate when they are not.
In simple terms, a DLA records the financial position between the company and its director, who is often (but not always) also a shareholder. Often, a director may take regular sums throughout the year, but rather than these being treated as a monthly salary, a dividend might historically have been voted at the company’s year end to clear those drawings. Alternatively, the director might lend the company money (for example, on start-up) and then repay themselves gradually. Either way, the account can move in both directions, and often does. The problem arises when the director takes more out than they have put in as this generates an overdrawn DLA. Unfortunately, borrowing money from a company is not without tax obligation.
There are essentially three ways to clear an overdrawn loan: the director can repay it from other personal funds; the company can vote a dividend (if profits permit); or the company can pay additional salary or bonus, although this has traditionally been less efficient because of the combined effect of income tax and National Insurance contributions (NICs).
If the loan is not repaid in a timely manner, tax implications arise. Clearly, a director who is able to essentially borrow money from their own company at low or no interest is enjoying a tax-free benefit, so it will be no surprise to learn that the benefit-in-kind rules will kick in. Additionally, where a loan to a company is left outstanding beyond the accounting year end, a corporation tax charge can be triggered (under CTA 2010, s 455).
Make your own kind of music
The benefit-in-kind rules that apply are those relating to ‘beneficial loans’. Put simply, if an employee (including a director) enjoys money without paying at least HMRC’s official rate of interest, somebody somewhere is getting a benefit.
The benefit applies where borrowings are more than £10,000 and the amount of benefit is equal to the interest foregone, so someone paying a low rate of interest on borrowings will suffer tax on a lower benefit than someone paying zero interest. The company must account for Class 1A NICs on the value and the director will pay income tax on the same amount personally. In practice, the charge is usually modest, but can be unexpected, particularly for directors who are used to treating drawings informally, as well as generating an additional compliance burden inrelation to forms P11Ds, etc. However, as the benefit is equal to the interest foregone at a maximum of 45%, it is more efficient to pay the benefit than suffer the interest.
Gimme, gimme, gimme
The more significant charge for most clients is the catchily monikered ‘section 455 tax’. This only applies to close companies, broadly those controlled by five or fewer participators, which includes the majority of owner-managed businesses.
If an overdrawn loan account remains outstanding nine months after the end of the company’s accounting period, HMRC considers that the director is simply using the company’s money rather than paying a dividend, so they tax it as if a dividend were paid. Clearly, the director has not actually received a dividend, so instead the company must pay tax equal to 33.75% (i.e., the same rate as the higher rate tax on a dividend) of the outstanding balance. Note that as the basic and higher dividend rates of tax are set to increase by 2% in April 2026, the section 455 tax rate will also increase to 35.75% with effect from 6 April 2026.
Unusually for tax, this is not a permanent tax. It can be fully reclaimed by the company once the loan is repaid. However, it is real cash leaving the business and the reclaim will generally be made long after the original payment, and the timing will depend on the accounting period of repayment and the corporation tax return submitted thereon. Besides, who would want to bank on HMRC processing times these days? That delay can cause frustration and can also cause issues if section 455 tax comes up in due diligence as part of a sale process.
You spin me right round, baby, right round
These rules create an incentive to repay the loan just before the nine-month date, but this can prove difficult if funds are not readily available. Some canny directors might come up with the genius plan of clearing a loan just before the trigger date and then immediately taking new drawings once the risk has passed.
Unfortunately, HMRC is onto this idea. If a director repays a loan and then, within thirty days, takes out a broadly similar amount, the repayment is not set against the old loan and HMRC treats the transaction as if the original loan had never been cleared. Similarly, where arrangements exist such that a repaid loan will be redrawn, the same rules will apply.
Example: Loan arrangements
Zack’s company has a year end of 28 February. He takes a loan from the company of £35,000 on 1 June 2024. To avoid the loan being outstanding nine months after the year end, to repay the company loan, Zack takes out a 90-day bank loan and repays the funds to the company on 24November 2025. Zack then takes a new loan from the company of £35,000 on 22 February 2026 to repay the bank loan, which was, of course, always his cunning plan.
Zack will be caught under the above ‘arrangements’ rule as clearly, arrangements exist for him to take out a further loan to repay the bank loan. The temporary repayment will therefore be ignored and section 455 tax will be due on the full £35,000 loan of £11,812.50 (i.e., £35,000 @ 33.75%).
Most of the time, advisers can manage these issues by planning around filing deadlines and ensuring that dividends or repayments are made in good time.
Bye bye buy?
DLAs can also be an issue when a sale is contemplated, particularly when considering whether to clear an overdrawn loan before completion, or to pay additional dividends running up to a sale.
Sellers may naturally assume the best plan is to clear a balance, to avoid any due diligence issues and leave the accounts neat and tidy for the buyer, who will expect to see a clean balance sheet. However, clearing a loan by dividend can trigger an income tax charge at up to 39.35% for additional rate taxpayers. In contrast, if the loan is left outstanding on the understanding that the loan will be cleared from cash proceeds, the net effect is that the same underlying value could end up being taxed at 24% (or 14 or 18% if business asset disposal relief is in play) as part of the capital gains tax calculation. The same treatment would apply if generating an overdrawn DLA by not declaring dividends,
But a deal isn’t done until a deal is done, and the nine-month deadline to clear a DLA does not just dissolve at the prospect of a sale. This can cause practical complications. If the company has an overdrawn loan at the year end before completion and the nine-month point falls after the sale, the section 455 charge may arise while the company is owned by the seller. The seller will have to suffer the tax because it arises in the company and although the refund will be repaid to the company, by this time it will be owned by the buyer. The seller will suffer the reduction in price for the lower levels of cash sloshing around from having paid the section 455 tax, but they are unlikely to receive full value for it in terms of negotiating for the future repayment of the tax. While some of the issues can be dealt with via contractual protection, careful timing in the run-up to a sale could avoid unnecessary tension in negotiations and delays in completion.
Overall, the rules surrounding DLAs are not complex, but can require careful planning, particularly around sale scenarios.
Practical tip
Timing can also be important in respect of large loan advances. A loan made to a director a month before the year end will need to be repaid within ten months. A loan made in the first month of an accounting period will benefit from up to 21 months before repayment is required.
