Our Client Account Manager Bethan Higdon provides key explanations and definitions on this common area of confusion for company directors.
What is a director’s loan?
As a director of a limited company, you can:
- Borrow money from your company
- Lend money to it, for instance to ease company cashflow struggles
Both of these types of transactions constitute ‘director’s loans’.
What is a Director’s Loan Account (DLA)?
Your DLA is the account through which these transactions are recorded.
If your company is borrowing more money from its director(s) than it is lending to it, then the account is in credit and the director(s) in question is a creditor of the company. If the director(s) borrow more, then the DLA is said to be ‘overdrawn’. Any director with an overdrawn DLA is liable to repay the appropriate amount to the company 9 months after the year end, to mitigate tax implications.
At your company year end, the DLA balance for your company is included on its balance sheet.
In what scenario should you borrow via a director’s loan?
Be aware there are heavy potential tax penalties in relation to overdrawn DLAs. A long-term overdrawn DLA can also make company stakeholders uneasy.
Given these risks and concerns, taking a director’s loan should be treated only as an emergency source of personal funds, when all other options have been utilised.
Your DLA should not be overdrawn for 30 days after repaying a director’s loan. HMRC frown upon directors who repeatedly put their DLA in an overdrawn position at the year end, only to repay this and borrow again instantly. Doing this can put you at risk of being pursued for tax avoidance.
What are the rules for repaying a director’s loan?
There is no legal limit to how much you can borrow from your company. However, your company needs to be able to continue to function effectively for the duration of your loan. Borrowing money your company cannot afford can lead to cashflow problems.
Your director’s loan must be repaid within 9 months of your company’s year-end, or you face a significant tax penalty. You will pay a corporation tax charge, known as S455 tax, at a rate of 32.5% (increasing to 33.75% from April 2022) on any unpaid loan amounts after this time.
You can apply to reclaim any S455 tax you have paid once you have repaid the outstanding loan, or it is written off or released. You can do this from 9 months after the end of the accounting period in which you repaid the loan. You can reclaim S455 tax up to four years after the relevant accounting period. You cannot reclaim any interest paid on this tax.
What else do you need to consider when contemplating borrowing via a director’s loan?
Your company is obliged to treat any loan made to you of over £10,000 as a ‘benefit in kind’ and report it on your annual P11D as part of your self-assessment tax return.
You will pay Class 1A National Insurance on the value of the benefit. You may also have to pay tax on the loan at the official rate of interest.
Any interest your company pays you in the event you lend it money via your DLA must also be included on your tax return. Your company must treat the interest paid to you as a business expense, and also deduct income tax at the basic rate of 20% at source. It will pay no corporation tax on the loan.
What level of interest do you pay on a director’s loan?
It is up to your company what interest rate it charges on your director’s loan. However, if the interest charged is below the official rate set by HMRC then the discount granted to the director may also be treated as a ‘benefit in kind’ by HMRC. This means that you may be taxed on the difference between the official rate and the rate you’re actually paying.
This situation can be avoided by repaying your director’s loan before your company’s corporation tax is paid. Your corporation tax payment deadline is 9 months after your financial year end.
As the above shows, director’s loans are quite a complex subject and should be managed carefully. Contact your accountant for advice before proceeding with a director’s loan.
Bethan Higdon MAAT
Client Account Manager
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