Firstly, what is s455 tax?
I've noticed over the years that one area where new directors sometimes struggle is the area of the directors' loan account and the appearance of section 445 tax (commonly called s455 tax) if ever their balance on the account goes overdrawn at the year-end. So let's look at what the s455 tax is.
S455 tax is a temporary tax levied on the company when a directors' loan account is in overdraft at the accounting year-end. It's payable at 33.75% of the amount owed. Once the overdraft gets paid, it's reclaimable on an LP2 form.
What is a directors' loan account?
The directors' loan account (DLA) records the ins and outs between the company and its director. When the director pays cash in, it is credited. When they draw out, the account gets debited. If the net balance is a debit, the DLA is overdrawn and deemed by the HMRC as potential income to be taxed.
When do directors' loans usually go overdrawn?
As an overdraft happens when a director draws out more cash than can be credited against their DLA, it stands to reason that the more the director can credit into their DLA, the better.
How can a director credit their DLA?
If a director inputs some form of value into the company without receiving payment in return, that amount is available to credit against their DLA.
Creditworthy actions can be:
- Not to take net pay accruing to them from the payroll.
- Not to take the cash value of dividends issued to them from the firm.
- Bringing other assets into the company without receiving payment for them.
With all of the cash value of the items above, instead of the company paying cash to the director, instead credits that director's DLA the cash value.
What happens when the DLA has overdrawn at the year-end?
An overdrawn DLA at the year-end will potentially trigger the s455 corporation tax charge.
Although, if the director pays the overdrawn amount back into the company within nine months of the year-end, the charge, although requiring reporting, will no longer need to be paid.
If repaying the DLA overdrawn balance within nine months
Balancing up the DLA before the nine-month deadline cancels the tax charge, although the following disclosures are still required:
- On the corporation tax return, the outstanding amount at year-end must be given, along with the date it got repaid.
- In the published accounts, the same information needs disclosure in the notes.
The s455 tax charge on the overdrawn directors' loan account
Assuming the DLA is still overdraft at the nine-month deadline, the s455 tax charge comes into play.
Currently (the financial year 2022/23), the s455 tax rate is 33.75% of the year-end overdraft balance of the DLA.
A simple example of an s455 tax calculation
The director owes £20,000 to the company at the accounting year-end.
Tax owing = £20,000 x 33.75% = £6,750.00
An example of an s455 tax calculation with the director paying off part of the loan
The director owes £20,000 to the company at the accounting year-end and pays £15,000 off six months after the year-end.
Tax owing = £5,000 x 33.75% = £1,687.50
When is the due date of the s455 tax charge?
As with standard corporation tax, the s455 tax is payable nine months and one day after the company's year-end date.
How can the tax be reclaimed?
Assuming the director has repaid the DLA overdraft down to at least zero, a reclaim for the amount of s455 tax already paid can get made with an L2P form submission to the HMRC.
S455 tax reclaims can be made via online or by post, see here for HMRC information on the L2P form
How can directors use planning to reduce their s455 tax?
Planning is a helpful exercise for directors, especially regarding cash flow. Forecasting can help the director take action to keep the account in credit.
Often, when a director lets their loan account becomes overdrawn, the reason is that they are drawing out cash for personal use (e.g. for their everyday cost of living).
The drawing of this cash from the company becomes as natural a routine as say, receiving a monthly salary from an employer.
If this amount regularly outweighs any credits awardable to the director, such as available dividends issued to them, then they'll go deeper into a DLA overdraft.
So a sensible approach is to run a cash flow forecast say every month to know several months out if the DLA balance will be going the wrong way. Let's say a three-month forecast showed the DLA sinking into debit by the third month; the director would have two months to stem the net decrease by coming up with ways to credit their DLA (perhaps creating more profits for dividend issue or drawing out less each month)
Income tax aspects of an overdrawn directors' loan account
If a DLA goes overdrawn to the tune of £10,000 or more, then the "Benefits in Kind" (BIK) rules kick into play. The amount owing to the company gets regarded as a "beneficial loan" and thus taxed and also assessed for a national insurance charge.
How is the DLA benefit in kind calculated?The amount of interest a director gets the benefit of not having to pay is deemed income and assessed for income tax and national insurance. Here are the official interest rates provided by HMRC. The current rate is 2% pa.
An example of the DLA benefit in kind amount taxable
Say a director's average DLA loan owing to the company was £20,000 & there was zero interest getting paid on it.
A benefit of 2% x £20,000 = £400 would be assessed as income by the director and would need to be disclosed on their tax return.
PAYE tax and NI would be due on this and it would be reportable via a P11D form.