Directors of personal and family companies often use their director’s loan account (DLA) as a flexible way to draw money or settle expenses. When managed well, this account supports cashflow and allows directors to meet personal or business costs without constant formality. However, complications arise when the DLA becomes overdrawn, particularly at the company’s year end. In such cases, a separate tax charge, known as section 455 tax, may be triggered.
Understanding how this tax works and how to manage repayments effectively is essential for any director who uses, or may use, a DLA. This guide explains what happens when the account is overdrawn, when the tax applies, and the potential consequences for both the company and the director.
What Is a Director’s Loan Account?
A director’s loan account is simply a record of financial transactions between a company and its director. These transactions may include:
- Cash drawn from the company
- Money lent to the company
- Company-paid personal expenses
- Director-paid company expenses
- Dividends and salaries credited to the account
If the account is in credit, the company owes money to the director. If it becomes overdrawn, the director owes money to the company.
Overdrawn accounts need careful attention, as tax charges can arise depending on timing and whether the company is classified as a close company.
Close Companies and Why They Matter
Most small limited companies fall within HMRC’s definition of a close company. A close company is typically controlled by:
- Five or fewer participators, or
- Any number of participators who are also directors.
A participator is an individual with an interest in the company’s income or capital. Because personal and family companies fit these criteria, they are subject to section 455 rules when a director’s loan remains outstanding after the financial year end.
When Section 455 Tax Applies
At the company’s year end, HMRC reviews whether the DLA is overdrawn. If it is, the crucial deadline is nine months and one day after the year end, which is also the due date for the corporation tax bill.
If the Loan Is Repaid Within Nine Months and One Day
If the director repays the loan before this deadline:
- Section 455 tax does not apply
- The company must still report the loan on form CT600A
- The form must show the amount outstanding at the year end and repayment dates
This ensures HMRC has visibility over the loan even if no section 455 charge is due.
If the Loan Remains Outstanding After the Deadline
If the loan is not cleared in time, the company must pay section 455 tax on the outstanding balance.
How Section 455 Tax Is Calculated
Section 455 tax is charged at a rate aligned with the upper dividend tax rate, currently 33.75%.
For example:
- Overdrawn DLA at year end: £20,000
- Amount still outstanding after nine months and one day: £20,000
- Section 455 tax due: £20,000 × 33.75% = £6,750
A Temporary Tax, Not Corporation Tax
Although paid alongside corporation tax, section 455 is a temporary charge. Once the director repays the loan, the company can reclaim the tax from HMRC. The refund becomes available nine months and one day after the end of the accounting period in which the repayment is made.
Anti-Avoidance: Preventing “Bed and Breakfasting” Loans
Some directors historically repaid their overdrawn DLA just before the deadline, only to withdraw funds again soon after. HMRC introduced anti-avoidance rules to prevent this practice.
For example:
- If a director repays a loan but takes out a similar loan shortly afterwards, HMRC may treat the repayment as ineffective.
Companies and directors must ensure that repayments are genuine and not offset by near-immediate further withdrawals intended to bypass the charge.
Clearing an Overdrawn Director’s Loan Account
Directors can clear an overdrawn DLA in several ways:
1. Repaying the Loan in Cash
This is the simplest method and avoids tax complications unless later withdrawals cause the loan to rise again.
2. Declaring a Dividend
A dividend can be credited to the DLA to clear or reduce the balance. However, the dividend itself is taxable as dividend income in the director’s hands.
This option only works if:
- The company has sufficient distributable profits
- The director holds shares that qualify for the dividend
3. Paying a Bonus or Salary
A bonus or extra salary payment can clear the DLA. Unlike dividends, bonuses attract:
- Income tax under PAYE
- Employee NIC
- Employer NIC
As these charges can be significant, the combined cost may exceed the section 455 tax, meaning that paying the temporary charge could be cheaper in the short term.
4. Waiving the Loan
A company may choose to formally write off a director’s loan. In this situation, the amount written off is treated as income for the director and taxed accordingly.
Benefit-in-Kind Implications for Loans Above £10,000
Where a director owes more than £10,000 at any point during the tax year, an additional tax implication arises.
The loan triggers a benefit-in-kind (BIK) charge because the director is receiving an interest-free or low-interest loan from the company.
The taxable benefit is the difference between:
- Interest at HMRC’s official rate, and
- Any interest actually paid by the director
The company must report this benefit on a P11D and pay Class 1A National Insurance on the taxable amount.
Avoiding this charge requires either:
- Repaying the loan to below £10,000
- Paying interest at the official HMRC rate
Common Mistakes Directors Make
1. Treating the Company Bank Account as a Personal Facility
Drawing cash without recording transactions leads to undetected overdrawn balances and unexpected tax charges.
2. Forgetting to Budget for Corporation Tax Deadlines
Repayments made after nine months and one day cannot prevent the section 455 charge.
3. Paying the Loan with Dividends When There Are No Profits
Declaring unlawful dividends creates additional problems and does not validly clear the loan.
4. Ignoring the Benefit-in-Kind Threshold
Exceeding £10,000 even briefly may trigger additional reporting and NIC.
5. Not Completing Form CT600A Correctly
This form must be completed for every accounting period in which the DLA is overdrawn, even if repaid.
Good Record-Keeping Is Essential
Directors should maintain clear and accurate DLA records that reflect:
- Personal expenses paid by the company
- Company expenses paid personally
- All cash withdrawals and repayments
- Timing of dividend credits
- Any salary or bonus adjustments
Accurate bookkeeping reduces the risk of accidental overdrawn balances and makes compliance with HMRC rules far easier.
This article is for general information only; seek tailored advice before acting.
