December 04, 2024
Article
In cases where a company director has borrowed money from the business for their own personal use, this is treated as a director’s loan account. All transactions with a director in the year are considered within a single loan account (per director), including funds both lent to and withdrawn from the company.
Where a director has an overdrawn loan balance exceeding £10,000 in the accounting year, they are required to pay interest to the company on their overdrawn balance at the HMRC official rate (2.25% since 6 April 2023). The interest receivable by the company is subject to corporation tax at the company’s marginal rate.
It may be the case that this interest is brought into the company accounts as a matter of course, however, it is well worth considering whether it would be financially advantageous for the beneficial loan arrangement to be included as a benefit in kind on a P11D instead of the director pay the interest.
How this works
Instead of the director paying interest to the company which is recognised in the company accounts and has corporation tax charged upon it, the company would prepare P11D forms which are submitted to HMRC, declaring the taxable value of the beneficial loan arrangement and the class 1A national insurance payable thereon. The payment of class 1A national insurance will be an allowable expense for the company and will therefore attract corporation tax relief. For the director, the loan will take the form of a benefit in kind on which income tax will be payable. This benefit in kind is taxed in the same way as employment income, rated at 20% for basic rate taxpayers, 40% for higher rate taxpayers and 45% for additional rate taxpayers.
EXAMPLE
Joe Bloggs is a director and 100% shareholder of Bloggs Limited. Bloggs Limited makes a taxable profit of £300,000 and is therefore ineligible for small profits relief and pays corporation tax at 25%.
Joe Bloggs prepares a self-assessment tax return and pays tax at the basic rate of 20% on employment income.
The company has an accounting year ending 31 March 2024 and Joe Bloggs has an overdrawn loan balance at this date totalling £100,000. There has been no movement in this loan balance for the whole accounting period.
Option 1: Payment of interest
Interest of £2,250 (£100,000 loan balance x 2.25% HMRC official rate) is paid by Joe Bloggs to the company.
The company recognises this as interest income and pays additional corporation tax of £563 (£2,250 x 25% corporation tax).
The total cost to both Joe and the company is therefore £2,813 (£2,250 interest + £563 corporation tax).
Option 2: Benefit in kind for P11D
The taxable value of the beneficial loan is £2,250 (£100,000 loan balance x 2.25% HMRC official rate).
This amount is reported under Bloggs Limited’s P11D and the company pays class 1A national insurance of £311 (£2,250 taxable value of beneficial loan x 13.8% national insurance).
The payment of class 1A national insurance is recorded in the company accounts and relief against corporation tax of £78 is claimed (£311 class 1A national insurance payment x 25% corporation tax).
Joe Bloggs includes the benefit in kind on his self-assessment tax return and pays income tax of £450 (£2,250 benefit in kind x 20% basic rate income tax).
The net cost to both Joe and the company is therefore £683 (£311 class 1A national insurance - £78 corporation tax relief + £450 income tax).
Example summary
In this instance, Joe Bloggs and Bloggs Limited can realise a combined saving of £2,130 by treating the loan as a benefit in kind rather than recognising interest through the company accounts.
Further consideration
Bearing in mind that the benefit in kind route involves only the payment of taxes on the interest rather than payment of the entire interest itself, the decision to treat the loan as a benefit in kind may seem like a no-brainer. However, there are some other factors which should be taken into account:
- Does the company already prepare a P11D? If so, the additional cost of having this prepared to include the beneficial loan is likely to be of little significance, but if no P11D is otherwise required, the cost of having this prepared may outweigh the savings, particularly if the value of the overdrawn loan is relatively low
- Is the administrative burden too great? P11Ds are prepared in accordance with the tax year, not a company’s specific accounting period, and are required to be filed by 6 July. The window for completion each year is therefore 6 April – 6 July, which can be a tight turnaround for providing accurate information, particularly if the company year end is anything other than 31 March as information from two accounting periods will be required.
- The potential savings may not be as great as in the example above if the company falls into the small profits band and pays corporation tax at 19%, or if the director is an additional or higher rate taxpayer and therefore pays income tax at 40% or 45%.
If you wish to discuss this topic any further and find out the best option for you, please contact your usual Albert Goodman representative.