Director’s loan accounts are a common feature of owner-managed businesses, but they create significant tax risks if not managed correctly. When a director borrows money from their company, it can trigger two distinct tax liabilities: a benefit in kind charge on the director and a temporary corporation tax charge on the company.
This case study walks through a typical scenario to demonstrate how these charges arise and the options for resolving the loan, providing a clear roadmap for advising clients in the 2026/27 tax year.
The Case Study: Director Alex and Innovate Ltd
- The Company: Innovate Ltd is a close company with a 31 December accounting year-end.
- The Director: Alex is the sole director and shareholder (a ‘participator’).
- The Loan: On 1 May 2025, Alex takes an interest-free loan of £20,000 from Innovate Ltd to fund a personal house extension. The loan is recorded in his Director’s Loan Account (DLA).
Alex does not repay the loan during the 2025/26 tax year. This single transaction creates two separate tax implications.
The Benefit in Kind Charge on Director Alex
When a company provides a director with a cheap or interest-free loan exceeding £10,000, it creates a taxable benefit in kind (BIK). This is because the director has received value from their employment—the use of money without paying a commercial rate of interest.
The taxable benefit is the difference between the interest that would be due at HMRC’s ‘official rate’ and the interest actually paid by the director.
Calculating the Benefit in Kind
For Alex’s £20,000 loan, we must calculate the ‘cash equivalent’ of the benefit for the 2025/26 tax year (ending 5 April 2026). Let’s assume the official rate of interest for 2025/26 is 2.25%. Since Alex paid no interest, the entire notional interest amount is the taxable benefit.
There are two methods to calculate this: the averaging method and the precise method. We will use the precise method as the loan was not outstanding for the full tax year.
- Loan Amount: £20,000
- Period Outstanding: 1 May 2025 to 5 April 2026 = 340 days
- Official Rate: 2.25%
Calculation: £20,000 × 2.25% × (340 ÷ 365 days) = £419.18
Tax Consequences for Alex and the Company
- For Alex: The £419.18 cash equivalent is treated as part of his employment earnings for the 2025/26 tax year. He must pay income tax on this amount at his marginal rate (20%, 40%, or 45%).
- For Innovate Ltd: The company must report this benefit on form P11D. It is also liable for Class 1A National Insurance Contributions (NICs) on the full value of the benefit (£419.18).
The Section 455 Charge on Innovate Ltd
A separate tax charge, commonly known as ‘s455 tax’, applies to the company itself. This is a powerful anti-avoidance measure designed to stop shareholders from extracting funds from their close company as loans instead of taxable salary or dividends.
The charge arises if a loan to a participator (which Alex is) is not repaid within nine months and one day of the company’s accounting period end.
Calculating the Section 455 Charge
- Company Year-End: 31 December 2025
- Repayment Deadline: 1 October 2026 (9 months and 1 day later)
- Loan Outstanding: £20,000
If Alex fails to repay the £20,000 loan by 1 October 2026, Innovate Ltd must pay a tax charge to HMRC. The rate of the charge is equal to the dividend upper rate for the tax year in which the loan was made. For a loan made in 2025/26, this rate is 33.75%.
Calculation: £20,000 × 33.75% = £6,750
This £6,750 tax is due on the same day as the company’s main corporation tax bill.
Crucially, Section 455 Tax is Refundable
This is not a permanent tax. It acts more like a deposit held by HMRC. Once the director repays the loan, the company can reclaim the s455 tax it paid. Relief is given nine months and one day after the end of the accounting period in which the loan is repaid.
How Can Alex Settle the Director’s Loan?
Alex has several options to clear his DLA and manage the tax consequences.
| Option |
Action |
Consequence for Director (Alex) |
Consequence for Company (Innovate Ltd) |
| 1. Repayment |
Alex repays the £20,000 from his personal funds. |
The BIK charge ceases from the date of repayment. No further income tax liability. |
If s455 tax was paid, the company can reclaim it from HMRC. |
| 2. Dividend |
Innovate Ltd declares a dividend sufficient to clear the loan balance. This is cleared via a book entry. |
Alex receives a dividend and is liable for tax at the dividend rates. |
The dividend payment clears the DLA, avoiding or triggering a refund of the s455 charge. |
| 3. Salary / Bonus |
The company pays Alex a bonus, and the net amount is credited to his DLA. |
The bonus is taxable as employment income and subject to PAYE and employee NICs. |
The bonus is a deductible expense for corporation tax but incurs employer NICs. It clears the DLA. |
| 4. Write-Off |
The company formally writes off or releases the loan. |
The written-off amount is treated as a dividend distribution, not earnings, and is taxed at dividend rates. |
The company cannot claim a corporation tax deduction for the write-off but can reclaim any s455 tax paid. |
Corporate Governance and Compliance
Beyond the tax implications, it is important to remember the company law requirements. Under the Companies Act 2006, a loan to a director generally requires approval from the company’s members (shareholders) via an ordinary resolution. Failure to secure proper approval can have serious legal consequences for the director.
Advisers should review DLA movements regularly to ensure both tax and corporate compliance are managed effectively.
For detailed guidance on beneficial loans, you should consult HMRC’s Employment Income Manual, starting at EIM26100. For the charge on loans to participants, refer to the Company Taxation Manual at CTM61500 and the primary legislation in the Corporation Tax Act 2010.
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