Sarah Bradford highlights the forthcoming increase to the rate at which section 455 tax is charged on outstanding ‘loans to participators’ and examines the implications of the rise.
Loans to director shareholders are a common occurrence in family and personal companies. However, to prevent directors having the use of the money indefinitely without paying any tax, provisions exist which levy a tax charge (under CTA 2010, s 455) on the company where the loan is outstanding on the date for which the corporation tax for the period in which the loan is made is due.
Nature of the section 455 tax charge
The charge applies in respect of outstanding loans to participators in a close company. Broadly, a ‘close’ company is one that is under the control of five or fewer participators. A ‘participator’ is usually a shareholder in the company.
Most personal and family companies are close companies, and directors of such companies are usually shareholders (and thus participators). Consequently, directors’ loans which remain outstanding at the trigger point (nine months and one day after the year end) are caught, and the company must pay section 455 tax on the outstanding loan balance.
Unlike other taxes, section 455 tax is a temporary tax which is repaid after the loan has been cleared; the company is eligible for a refund of the tax nine months and one day after the end of the accounting period in which the loan was repaid.
Rate of section 455 tax
The rate of section 455 tax is aligned with the dividend upper rate of tax. Until 5 April 2022, the rate is 32.5%.
The dividend tax rates are increased by 1.25% from 6 April 2022 as part of a package of measures to provide ring-fenced funding for health and adult social care costs. From that date, the upper dividend rate is 33.75%. The rate of section 455 tax is also increased to 33.75% from 6 April 2022.
The rate at which the tax is charged is the rate prevailing on the date that the loan was made, not the rate on the date that the tax is actually due. Thus, the rate of section 455 tax for loans made before 6 April 2022 (and after 5 April 2016) is 32.5%, and the rate applying where the outstanding loan was made on or after 6 April 2022 is 33.75%.
The increase in the section 455 tax will have implications for directors with loans from a personal or family company, and for those thinking of taking the loan in the near future. The change in rate means that directors need to consider the timing of any new loans, particularly if they are unlikely to repay them by the trigger date, and also the order in which any outstanding loans are cleared.
Timing of new loans
As the rate at which section 455 tax is charged is the rate prevailing on the date on which the loan was taken out, the rate of tax charged will be lower where the loan was taken out prior to 6 April 2022 than for loans taken out on or after that date. Taking a loan from 6 April 2022 rather than before this date will mean that an additional £12.50 of section 455 tax is due for every £1,000 of outstanding loan at the trigger date.
Example 1: ‘Old’ and ‘new’ section 455 rate
Albert is the director of his personal company, A Ltd. The company prepares accounts to 31 May each year. Albert is planning on taking a loan of £30,000 prior to the 31 May 2022 year end. He does not expect to repay it by the corporation tax due date of 1 March 2023.
If he takes the loan out prior to 6 April 2022, section 455 tax will be payable at the rate of 32.5%, and if the loan is not repaid by 1 March 2023, A Ltd will have to pay section 455 tax of £9,750 (i.e., £30,000 @ 32.5%).
However, if Albert takes the loan out after 6 April 2022 and on or before 31 May 2022, and if the loan is not repaid by 1 March 2023, A Ltd will have to pay section 455 tax of £10,125 (i.e., £30,000 @ 33.75%).
Delaying taking the loan until after 6 April 2022 will increase the section 455 tax payable by £375.
(NB Albert will also have to pay a benefit-in-kind charge on the outstanding loan.)
Choosing which loan to repay
Section 455 tax is a temporary tax; it is repaid after the outstanding loan has been cleared. A repayment can be claimed from nine months and one day after the end of the accounting period in which the loan balance was cleared.
The loan may be cleared in various ways; for example, by introducing funds from outside the company, declaring a dividend or by setting a bonus or salary payment against the loan.
If the director has several loans outstanding, it makes sense to clear those loans which attract a higher rate of section 455 tax first.
The optimal repayment order is as follows:
- Loans made on or after 6 April 2022 (for which the rate of tax is 33.75%).
- Loans made between 6 April 2016 and 5 April 2022 (for which the rate of tax is 32.5%).
-
Loans made before 6 April 2016 (for which the rate of tax is 25%).
Example 2: Priority of loan repayments
Bert is a director of his family company, B Ltd. He prepares accounts to 30 June each year.
In April 2015, he took a loan of £20,000 from B Ltd. The company paid section 455 tax of £5,000 (i.e., 25% of £20,000) on 1 March 2016.
He took a further loan of £10,000 in May 2018, on which the company paid section 455 tax of £4,875 (i.e., £15,000 @ 32.5%) on 1 March 2019.
Bert is having building work done in May 2022 and plans to take a further loan of £35,000 on 1 May 2022. If he does not clear the loan by 1 April 2023, the company will have to pay section 455 tax of £10,125 (i.e., £30,000 @ 33.75%).
He has an endowment policy that will mature in December 2022, the proceeds of which are £50,000. He plans to use this to clear the loans. To make the best use of this money to secure the maximum tax savings or repayments, he should clear the loans as follows:
- Loan of £30,000 made on 1 May 2022. As the loan is cleared by the trigger date of 1 April2023, there is no section 455 tax for the company to pay. This will save the company tax of £10,125.
- Loan of £15,000 made in July 2015. This will generate a repayment of £4,875 on 1 April 2024.
-
£5,000 of the £20,000 loan made in July 2015. This will generate a repayment of £1,250 on 1 April 2024.
Using the £50,000 in this way will save tax or generate repayments of £16,240.
Had he cleared the loans in chronological order, he would have received a repayment of £5,000 in respect of the 2015 loan and a repayment of £4,875 in respect of the 2018 loan. He would only have been able to clear £15,000 of the 2022 loan (saving Section 455 tax of £5,062.50). He would also need to pay Section 455 tax of £5062.50 on 1 April 2023 on the outstanding loan balance of £15,000 (i.e., £15,000 @ 33.75%).
It is beneficial for Bert to clear the loans which attract the highest rate of section 455 tax first, rather than clearing them in chronological order.
Practical tip
The increase in the rate of section 455 tax from 6 April 2022 means that all directors’ loans are not equal. If a director plans to take out a new loan which will not be cleared by the trigger date, where possible the loan should be taken out before 6 April 2022, as this will reduce the rate of section 455 tax payable on the loan. If the director has outstanding loans which are to be cleared, those attracting the highest rate of section 455 tax should be cleared first to optimise the tax savings or tax repayments.
