A director’s loan is created when you as a director get money from your company that is not a salary, dividend or expense repayment. Therefore, the director owes the company money and this will need to be repaid. We explain the consequences of this type of loan below.
A director’s loan can also be created when you as a director pay money into the business for working capital purposes or initial injection of funds on start-up. As a result, the company now owes you money and you become a company creditor.
Why might I borrow from my company?
Director’s loans are typically short-term and cover one-off expenses, such as unexpected bills and allows for additional money to be withdrawn form the company in addition to salary and dividends. Due to the tax consequences of drawing loans for your company, this type of loan should not be used routinely but kept in reserve as an emergency source of funds.
There is no maximum amount that a director is allowed to borrow through a director’s loan, however this depends on the cashflow of the business and how much it can lend before it will suffer from cash flow shortage.
How are loan transactions recorded?
Each director will have their own director’s loan account (DLA) and this records all money that has either been loaned to the business or borrowed from the company. At the year-end of the company, the DLA will be included in the Balance Sheet of the annual accounts. It will either be an asset (where the director owes the company money) or a liability (where the company owes the director money).
The DLA will include records of:
- Cash withdrawals and repayments you make as a director,
- Personal expenses paid with company money or a company credit card,
- Business expenses paid with personal funds,
- Interest charged on the loan.
What are the issues with taking a loan out of my company?
If a director’s loan taken out of the company is no more than £10,000, it can be borrowed tax-free so long as it is repaid within 9 months from the date of the company’s year-end. If the director misses repayment of this loan by the deadline, then the company will have to pay a higher rate of tax, known as s455 tax, on the outstanding balance of the director’s loan at 32.5%!
This tax can be claimed back from HMRC by the company, but only once the loan has been repaid. This tax is then reclaimed 9 months after the end of the accounting period in which the loan was repaid.
Should the loan not be repaid, it is considered a company asset and if the company is insolvent, a liquidator could pursue the director to repay the balance of the loan.
There are also personal tax implications of having loan accounts higher than £10,000. If interest is not charged on the loan account, then this will be treated as a benefit in kind and will need to be recorded on a P11D and Class 1A National Insurance is payable by the company at 13.8%.
This benefit in kind would also be reported on your personal tax return and you will have personal tax liability implications.
To avoid the interest-free loan issue, HMRC’s official rate of interest should be charged on the loan account. This is currently 2.00% but this does change over time in line with base rate changes.
How can I repay my loan account?
There are 3 ways you can choose to repay a director’s loan:
- Pay out dividends: Should there be sufficient profit in the company to do so, you can issue a dividend to clear your loan account. Rather than paying this to your personal account, it is instead an accounting transaction which clears your loan account. This dividend would then be added to your personal tax return in addition to any other dividends you have physically drawn in that tax year.
- Pay salary: If the company’s profits are not enough to pay out dividends, salaries are a legitimate business expense. Rather than paying your salary into your personal bank account, this would be paid into your director’s loan account. Please note that this salary could be liable to PAYE and National Insurance.
- Pay cash: The best way to repay your loan account, would be to physically transfer funds from your personal bank account to the company’s bank account. This will then show HMRC a genuine repayment of the loan which is outside of the company’s finances.
What if I lend money to my company?
Where the director has loaned money to the business, this can be claimed back at any point tax-free! It does not have to be withdrawn as salary or dividends and can be simply taken out of the business bank account (so long as cashflow allows).
You can also charge interest on your loan to your company, and any interest that the company pays you is considered income and must be recorded on your personal tax return. This interest is treated as a business expense for the company; however, income tax is deducted at source from this payment (at the basic rate of 20%). This income tax is then payable by the company to HMRC each quarter interest is charged on the loan.
Director’s loan accounts can be tax efficient for profit extraction if your company owes you money but they can be extremely costly to your business should you owe your company money. Regular tax planning and management accounts should be prepared and reviewed to ensure there are no issues.
If you require management accounts or need tax planning to avoid any potential Directors Loan Account issues, please get in touch.
The content in this blog is correct as at 31 August 2021.