A Director’s Loan – What do I need to know?
Let us start with clarifying, what exactly is a director’s loan?
A director’s loan is typically when you receive money from your ‘close company’ that is not a salary, dividend (money you can draw from your company on declared profit), a repaid expense, or money that you have previously given to or loaned your company. We say typically because a director can also loan money to their company, and this is covered later in this article.
A close company is a limited company with five or fewer ‘participators’, or a limited company of which all the ‘participators’ are also directors. For most small, limited companies, ‘participators’ will just mean shareholders but can also extend to mean close family members.
For completeness a director’s loan can also be taken by close family members, such as your spouse or civil partner, and your children.
A director’s loan from the company is seen as a beneficial loan arrangement by HMRC and without careful thought, especially in the start-up years, you can easily find yourself in a super scarry tax position with tax rates currently set at 33.75% on the balance of the director’s loan account. For this reason, JT AccountS recommend extreme control is exercised in the use of a director’s loan and advice is taken if you are already in a super scarry tax position.
At the time of writing, we are in a cost-of-living crisis. It is easily forgotten, especially with owner managed businesses that limited company money is not personal money. Limited company money can only leave the company to directors and participators in the form of salary, dividend, or loan. It is the loan element of these three options, and the rules around those loans, that will often trip directors up and can end in tears!
A director’s loan from the company can affect the following taxes:
- Section 455 tax on the business.
- Dividend tax on the director personally if the loan is ‘written off’.
- National insurance on the director personally, and the company as a ‘benefit in kind’ tax if the loan is ‘written off’ or ‘released’ (not repaid) including if the company goes into liquidation.
These are explained in greater detail in this article.
Borrowing money from your company can carry serious consequences, especially during liquidation where the debt can become personal; and a director’s loan will have far reaching consequences for both your company and you personally, depending on how, when and if this loan is repaid.
In our fifteen years of practice, we have seen many businesses taking money from their company without any thought given to how this will affect them at the end of their financial year. Imagine the shock when in addition to the normal corporation tax liability they also discover there is an additional tax liability due (Section 455 tax), because money has been removed from the company that can only be accounted for through the director’s loan account.
How is a director’s loan assessed and when do I pay tax on a director’s loan?
Currently you pay tax on a director’s loan when the value of the loan exceeds £10,000 in your current financial year. At £10,001 you are liable to pay tax on the whole loan until it is repaid.
HMRC assess that you have taken this money as a director’s loan and the tax you pay is known as Section 455 tax. Your personal and company tax responsibilities depend on how the loan is settled (repaid).
You have 9 months from the end of your accounting period to repay, release or write-off a director’s loan without having to also pay additional tax on the loan. If you do not, then tax is payable on the full loan at 33.75%. This amount is paid to HMRC with your corporation tax, but Section 455 tax is a recoverable payment. There are time limits and different routes for a reclaim, depending on when the loan is repaid or written off.
It is possible for a director’s loan to be written off. However, director’s loans that are written off are treated as dividend income in the tax year the loan is written off and charged at the dividend upper rate of 33.75%. This dividend tax is on the individual through their personal self-assessment and not through the company, and therefore is not recoverable.
Can I avoid Section 455 tax?
Yes. To avoid having to pay Section 455 tax the director’s loan must be repaid or written off within 9 months of the end of the accounting period (year-end).
Can I avoid a benefit in kind?
You may also need to consider Class 1A national insurance contributions. Class 1A national insurance is a paid by both the person and the company and notified through the P11D system; this is because a director’s loan is recognised as a ‘benefit in kind’. If the loan is ‘written off’ or ‘released’ (not repaid) including if the company goes into liquidation, Class 1 national insurance becomes payable. This will eventually result in a P11D reporting. There are some unpleasant consequences for missed P11D reporting and the dates for reporting will not necessarily align with a company accounting period. There are strict timelines for reporting and paying Class 1A national insurance to HMRC.
A benefit in kind may not arise, if, and only if interest is paid on the loan. There must be a genuine intention and obligation to pay interest on the loan to be deemed as not a benefit in kind. HMRC will expect to see written evidence of this. It is always best to seek professional advice on this.
Is it still a director’s loan when I am lending money to my company?
Absolutely. Although the rules are different. In this scenario the director is entitled to charge the company interest on the money they have lent to the business. The interest payment is an expense in the company’s accounts, which reduces the profits chargeable to corporation tax. Interest charged to a company by a director needs to be reported on a paper form CT61 obtained from HMRC.
The use of director’s loan interest can be a tax-effective method of extracting money from a limited company. However, although there is favourable tax treatment for interest, interest charged to a limited company on a director’s loan is an assessable income the director through self-assessment, and but should always be considered along with salary and dividends.
If a Directors Loan Account has built up over time, such as initial start-up capital from the director, personal funding for asset expenditure, or dividends not yet taken as cash, and if the company is profitable, or expected to become such, it can be sensible to charge the company interest on this loan which is owing to the director.
The interest can be accrued and paid out when cash flow permits, and interest rates could be up to 8%, which some externals lenders would charge. However, interest at this rate would need to be able to be justified to HMRC.
In summary, if you charge interest, the interest charged to your company for a director’s loan will count as both a business expense for your company, and a personal income for you. You must report the income on a personal self-assessment tax return.
Your company will be required to deduct basic rate tax of 20% from the interest due to you before it is paid. This tax will need to be paid to HMRC on a quarterly basis.
Disclaimer: Please note that the content of this article is correct at the time of publication. It relies on legislation at the time of publication which may become unreliable in future years. Always check you are seeking the most current advice available.
For further advice surrounding director’s loans from or to a limited company, please, get in touch email@example.com.
Practice Number: 21331
Jacqueline Tetley is licensed and regulated by AAT under licence number 5096.