Being a director of a limited company comes with lots of responsibilities. One aspect of the role, which sometimes gets played down, is understanding the myriad of complex rules and legislation that come with running a limited company.
A Director’s Loan is one of these complicated pieces of legislation that director’s need to be familiar with.
Don’t panic if you don’t know much about it, as this guide goes into great depth and looks at what a director’s loan is, discusses the guidelines you need to follow and covers the tax obligations of a director’s loan.
Director’s Loan explained
One of the advantages of a limited company is your personal liability is limited. But on the flipside, any money that is held within the company belongs to it and not you personally.
This is something that can easily be overlooked, but it can have serious consequences for you as a director if you take money out of the company without following the correct procedures.
HMRC defines a Director’s Loan as “money that is taken from the company that isn’t either a salary, dividend or expense repayment, or money that you’ve previously paid into or loaned the company.”
In summary, any money that is taken out of the company for any reason other than what has been explained, must be recorded in your personal director’s loan account.
Who can take a Director’s Loan?
The clues in the name, only a director can take a Director’s Loan.
For clarification, a director is someone who manages the day-to-day activities, including operational, financial and administrative, of the company.
A director is appointed by the company’s shareholders and in small limited companies, the shareholder and director may be the same person.
It’s a legal requirement that UK limited companies have one director, and that person must be over 16 years and must not be disqualified from being a director.
The director doesn’t have to reside in the UK, but the company must have a UK registered address.
Why take a Director’s Loan?
There may be times when you need extra money, such as having to pay for unexpected repairs to your property.
Whatever, the reason, any money that you take out of the company which isn’t a salary, dividend or expense repayment is classed as a Director’s Loan and must be recorded in your personal Director’s Loan Account (DLA).
At the end, you may either owe the company money or it will owe you money. Either way, you must record this as an asset or liability on the balance sheet section of your company’s annual accounts.
What is a Director’s Loan Account?
A Director’s Loan Account is a record of transactions (asides salary and dividends) between the company and its directors.
Two transactions are typically recorded on a Director’s Loan Account, these are;
- Cash withdraws from the company
- Personal expenses that are paid for using company money or credit card
We get a lot of questions about expenses. As a rule, a legitimate business expense is deemed by HMRC as, “being incurred wholly, exclusively and necessarily for the running of the business.”
If it has a dual purpose i.e. has a personal use as well as business use, it’ll be classed as a personal expense.
Examples of allowable business expenses include; accounting or bank fees, marketing and advertising costs, insurance costs and rent.
Our Expenses Guide has a full list of allowable business expenses.
To avoid confusion and to stop your company’s accounts from becoming ‘messy’ we strongly advise against paying for personal expenses with the company’s money.
How to take a Director’s Loan
Taking a Director’s Loan is not as straightforward as withdrawing money from the company’s account.
Firstly, you need approval from the company shareholders, particularly if the loan is over £10,000. If you’re the only shareholder, getting approval is fairly easy.
A copy of this approval must be kept in writing.
When to repay a Director’s Loan
HMRC rules state that loans must be repaid within nine months of your company’s year-end (the date your company’s accounting period ends) otherwise you’ll pay additional tax.
Are Director’s Loans taxable?
This is the most frequently asked question about Director’s Loans. The answer unsurprisingly isn’t straight forward.
If tax is due on the loan, depends on when the loan is repaid.
If you repay the entire loan within nine months and one day of your company’s year-end, no tax is owed.
If your Director’s Loan Account is overdrawn on this date, additional Corporation Tax of 32.5% is owed – it’s referred to as Corporation Tax, but it’s actually called Section 455 CTA Tax.
Say you borrowed £6,000 on 11th May 2019 and your company’s year-end is 31st October 2019. You’ll have until 1st August 2020 to repay the loan.
If you don’t it, you may have to pay 32.5% of £6,000 = £1,950 in addition to your Corporation Tax.
If you pay off some of the loan within the nine months and 1-day threshold, you’ll pay tax at 32.5% on the outstanding amount e.g. £3,000 x 32.5% = £975.
There’s good news though, as the tax charge is repaid to you by HMRC, once you clear the full amount of the loan.
How to repay the loan
The easiest way to repay a Director’s Loan is to use a dividend payment or salary to move the money back into the company’s bank account.
What if I can’t repay the loan?
We’re sure you intend to repay the loan; however, life isn’t straightforward, and you may find yourself in a situation where you don’t have the funds to repay it. For instance, a contract may suddenly end, or your next contract gets pushed back, leaving you with a shortfall in your finances.
The ideal scenario is that you have enough money in the company’s bank account to clear the loan by taking a dividend that is equivalent to the loan amount. This will deem the loan to be a dividend under the Income Tax (Trading and Other Income) Act 2005.
However, if by failing to repay the loan and placing the company in financial difficulties that it has to be liquidated, the liquidator can chase you for repayment.
In extreme cases, you could up in court or even be made bankrupt. Being declared bankrupt has serious consequences, for example, you can be prevented from being a director of another limited company, you can’t start or manage another company without the consent of the court and you’re prevented from a taking a loan over £500 without informing the lender of your bankruptcy.
Bed and Breakfasting
‘Bed and Breakfasting’ is a term referred to describe a situation that aims to avoid paying tax on a Director’s Loan.
Bed and Breakfasting is said to occur when a director repays the loan in full before their year-end to avoid penalties, to then immediately take another loan, with the intention never repaying it.
HMRC has implemented a measure to prevent this; when a loan over £10,000 is repaid by the director, no other loans in excess of £10,000 can be taken within 30 days. If this happens, the entire loan will be taxed.
It’s important to point out that loans that are taken outside of the 30 days may still be taxed, particularly if it’s in excess of £15,000:
The rules state that if a director takes a loan that is over £15,000, and before any repayment is made there is an intention by the director to take out a future loan over £5,000 that isn’t matched to another repayment, the Bed and Breakfast rules will apply.
The rules surrounding Bed and Breakfast are very complex and we advise you to seek advice from an accountant.
Is a Director’s Loan a Benefit in Kind?
Benefits in Kind sometimes referred to as ‘perks’, are benefits you receive from the company that isn’t included in your salary or wage. It could be a service you use personally but which the company pays for.
HMRC levy a tax on Benefits in Kind to prevent them from replacing your salary.
HMRC will deem a Director’s Loan to be a Benefit in Kind if:
- The loan exceeds £10,000 at any time
- You’re not paying interest on the loan
- The interest you’re paying is below HMRC’s average beneficial loan rate
If the loan meets any of the criteria set out above, it’ll be classed as a Benefit in Kind and you’ll be required to include it on a P11D. If the loan is under £10,000 and no interest is charged this is not a benefit.
You’re also required to include the loan’s cash value equivalent on your personal self-assessment tax return.
To calculate the cash value equivalent, you’ll have to refer HMRC’s list of official rates.
As an example, say you took out a loan of £6,000 in May 2019, the cash value equivalent will be £150.
Your limited company would pay Class 1A National Insurance on the loan’s cash value equivalent, £150 x 13.8% = £20.70.
You as a director of the limited company would also pay Income Tax on the cash value equivalent. The amount depends on which tax band you fall into. If you a basic tax rate payer, you’d pay £30 (£150 x 20%).
To avoid paying these charges, we recommend paying interest on the loan at the same rate (or higher) to HMRC’s average beneficial loan rate.
Does HMRC monitor Director’s Loans?
Yes, they do! In fact, they pay close attention to accounts that are regularly overdrawn. If they make the decision that your loan is, in fact, a salary, they’ll charge Income Tax and National Insurance on the amount.
Our advice is to monitor your account closely to ensure your withdrawals don’t go over £10,000.
Should I take out a Director’s Loan?
Taking a Director’s Loan can be handy in certain circumstances, such as if you experience unexpected expenses. However, you should plan on paying it off as soon as possible to avoid the S455 tax charge.
If you find you’re struggling to repay the loan, you should consider repaying it using a dividend payment (only if the company’s profits allow it) – as a side note, personal tax charges may apply to the dividend payment.
In summary, before considering a Director’s loan, seek professional advice from an experienced accountant because as you see, there are lots to consider.
If after reading this comprehensive guide, you have any further questions please get in touch with us on 01962 867550 or send us a message via our website.