A US citizen who borrows from a UK company that is a controlled foreign corporation can be taxed in the United States as if the company had paid out part of its profit. Section 956 of the Internal Revenue Code treats a loan to a related US person as an investment in United States property, and the US shareholder includes an amount in income each year the loan is outstanding, limited by the company's earnings. The UK applies its own rules to the same director's loan account, with a charge on the company if the loan is not repaid in time and a possible benefit in kind on the director.
This post is for US founders and owner-directors of UK limited companies who draw money through a director's loan account, and for the bookkeepers who keep those accounts. It goes further than the controlled foreign corporation sections of our guide to US-UK tax for founders, fund managers and executives. It covers what counts as United States property, how earnings already taxed reduce the charge, why individuals did not get the relief that corporations received, the UK position, a worked example and how the loan is reported on Form 5471.
Can a director's loan from a UK company be taxed in the US
Yes, where the company is a controlled foreign corporation and the borrower is one of its US shareholders. Section 956 treats the loan as the company investing its earnings in the United States. The US shareholder then includes a share of that investment in income, even though nothing has been paid out as a dividend.
Without it, a controlled foreign corporation could lend its profit to its American owner and achieve the effect of a dividend with no US tax charge. It sits alongside Subpart F and net CFC tested income, which our post on net CFC tested income explains.
Under section 7701 of the Code, a United States person includes a citizen or resident of the United States, so a US citizen living in London is one. An overdrawn director's loan account is a debt owed by that director. What matters for US purposes is that the company holds an obligation of a US person who is also its US shareholder.
What counts as United States property under section 956
United States property includes tangible property located in the US, stock of a US corporation, an obligation of a United States person and certain rights to use intellectual property in the US. A loan from the company to its US shareholder is an obligation of a United States person, and the usual exceptions do not cover it.
The statute lists exceptions. One excludes obligations of a US person that is not a domestic corporation, but only where that person is not a US shareholder of the company, so it does not protect the owner who borrows. Another covers obligations arising from the sale or processing of property in the ordinary course of business, kept within amounts that would be ordinary and necessary between unrelated parties. A personal loan to a director is not a trade receivable of that kind.
The amount taken into account is measured by averaging the United States property the company holds at the close of each quarter of its tax year. A balance that sits overdrawn across quarter ends therefore counts, while timing is a point to review on the facts rather than something to engineer. The arrangements that usually need checking are these.
- An overdrawn director's loan account that is not cleared by salary or dividend
- A formal loan agreement between the company and its US owner
- The company paying personal costs that are booked to the director's account
- A guarantee or pledge by the company of a US owner's personal borrowing, such as a mortgage
How earnings already taxed in the US change the result
The section 956 amount is limited by the company's earnings and is reduced by earnings that have already been included in the US shareholder's income. Section 959 then stops the same earnings being taxed twice. A founder who already reports net CFC tested income each year may find that the loan adds little or nothing further.
In outline, the US shareholder's amount is the lesser of a share of the average United States property held, reduced by certain earnings previously taxed, and a share of the company's applicable earnings. A company that has made losses or distributed its profit may have little for the rule to reach.
Earnings that have already been taxed to the US shareholder become previously taxed earnings and profits. They can be distributed later without a second US income tax charge, and they are not included again under section 956. This is why records matter. The pools are tracked year by year on Schedules J and P of the Instructions for Form 5471 (opens the official IRS page in a new tab), and a founder who has never kept them may find the loan taxed when it would not have been. Our post on salary or dividends for a US founder explains how the same pools affect a later dividend.
Why individual owners do not get the relief corporations got
In 2019 the Treasury issued final regulations reducing the section 956 amount for corporate US shareholders by the dividends received deduction under section 245A that they would have on an actual distribution. Section 245A is available only to a domestic corporation. An individual founder is therefore left with the full section 956 inclusion.
The logic of the regulations is that a US corporation could generally receive a dividend from its foreign subsidiary with no further US tax, so taxing it on a deemed repatriation through a loan made little sense. The Form 5471 instructions reflect this: the worksheet that computes the section 956 amount includes a line for the hypothetical section 245A deduction, and that line is zero for non-corporate shareholders.
The result is that the rule still matters most for the people the UK tax system expects to use director's loans: individuals who own and run their own companies. Advice written for US multinationals does not carry over. A section 962 election, under which an individual is taxed on certain inclusions as if a US corporation, is one of the options to review with our international tax team, alongside its own costs when profits are later distributed.
What the UK charges on an overdrawn director's loan account
If a shareholder director owes the company money at the end of its accounting period and does not repay it within nine months, the company pays a temporary charge to Corporation Tax (opens the official GOV.UK page in a new tab) on the outstanding balance, often called the section 455 charge. The company can reclaim it after the loan is repaid, but not the interest on it.
HMRC's guidance on director's loans sets the rate of this charge, which is higher than the main rate of corporation tax, and explains that relief becomes due nine months and one day after the end of the accounting period in which the loan was repaid, released or written off. It falls on the company, not on the director, so it is not a tax the US owner can credit against a personal US liability.
The director can also be taxed personally. Where a shareholder director owes the company more than a threshold set by HMRC at any time in the year, and pays interest below HMRC's official rate, the difference can be a taxable benefit in kind reported through Self Assessment. If the company writes the loan off, HMRC treats it as income of the director, and National Insurance can be due through payroll.
- Section 455 charge on the company for loans unrepaid nine months after the year end
- Reclaim of that charge once the loan is repaid, released or written off
- Benefit in kind on the director for a loan above HMRC's threshold at a low interest rate
- Income tax on the director if the loan is written off
A worked example of a founder borrowing to buy a home
A US citizen living in Bristol owns all the shares in a UK consultancy that has retained several years of profit. She borrows from the company through her director's loan account to fund a house deposit, intending to repay it from future dividends. Both countries then see the same balance differently.
In the UK, if the balance is still outstanding nine months after the company's year end, the company pays the section 455 charge, and she may have a benefit in kind if she pays little or no interest. A later dividend used to clear the account is taxed in the UK, and the company reclaims its charge only after repayment.
In the US, the loan is an obligation of a US shareholder held by her controlled foreign corporation. Her section 956 amount is measured by the balance at each quarter end, limited by the company's earnings and reduced by earnings she has already reported, for example as net CFC tested income on Form 8992 (opens the official IRS page in a new tab). Any remaining inclusion goes on her Form 1040, due on 15 April with an automatic extension to 15 June for filers abroad. The UK charges in the same year relate to different income, so a foreign tax credit (opens the official IRS page in a new tab) may not be available to match them, and the position should be modelled before she draws the money.
Why the loan has to be reported on Form 5471
The US owner of a controlled foreign corporation files Form 5471 (opens the official IRS page in a new tab) each year, and the form asks about both the loan and the inclusion. The initial penalty for a missing form is $10,000 for each year, and until it is filed the period for assessing the whole return can stay open.
Schedule M reports transactions between the company and its shareholders and other related persons, including the largest outstanding balance of amounts loaned during the year. The section 956 amount is computed on a worksheet in the instructions and carried to Schedule I. Previously taxed earnings are tracked on Schedules J and P. Our post on Form 5471 for a one-person UK limited company walks through who files which schedules.
An account that mixes salary, expenses and personal spending is hard to analyse years later. Our business tax returns service reconciles the UK account with the figures on Form 5471, and credits are claimed on Form 1116. The guide for founders, fund managers and executives covers the wider company rules. The options to review before drawing money include these.
- Taking the money as salary or a dividend instead of a loan
- Repaying an existing balance and documenting the source of repayment
- Confirming the company's earnings pools and previously taxed earnings
- A section 962 election, weighed against its later cost on distribution
- Charging interest at a commercial rate and recording it in both sets of books
General information, not advice. The right answer depends on your circumstances and the tax year concerned.
