If you run a limited company, youmight have heard the expression ‘directors’ loan’. But what is a directors’loan? Can you take one out of your own company? Is a directors’ loan taxable?And what are the implications for your finances? You can get all those answersand more right here.
The Government defines a directors’ loan like this:
‘A directors’ loan is whenyou (or other close family members) get money from your company that isn’t:
In short, it’s defined as taking moremoney out than you’ve put in. It’s your responsibility to keep a record of anymoney you borrow from the company. This is called a directors’ loan account.
HMRCconsiders a director’s loan to be a benefit in kind if:
If the loan meets these criteria and qualifies as a benefit in kind, you’ll have to include it in your company’s P11D. You’ll also have to record the loan’s cash-equivalent value on your personal self-assessment tax return.
To calculate the cash-equivalent value, you’ll need to refer to HMRC’s official rates.
Let’s sayyou borrowed £10,000 in August 2017. In 2017-18, the official rate is 2.5percent. So, your cash-equivalent value is £10,000 x 2.5%. That’s £250.
Thecompany would pay Class1A National Insurance on the loan at 13.8 percent of thecash-equivalent value. That’s £34.50.
You, onthe other hand, would have to pay income tax. if you’re a basic rate taxpayer, your personal tax liability will be 20%of the cash-equivalent value. That’s £50.
Want toavoid these tax payments? You could pay your company interest on your loan atthe same level or higher than HMRC’s rates. With the above example, you’d payyour company £250 in interest when you repay the loan.
Maybe you need to buy a house or a newcar. If you’re the director of a limited company, you can take money from thecompany’s business bank account.
If the money isn’t your salary, adividend or an expense repayment, it’s automatically classed as a directors’loan.
You can’t just raid the companyaccount willy-nilly, however. Directors’ loans must be approved by theshareholders. Especially if the loan is over £10,000. Directors’ loans becomewithdrawn when you take company money from the account without paying wages ordeclaring dividends.
If you’re the sole director and shareholder,that’s pretty easy to do.
You’ll have to keep a record of the shareholders’ approval (that is, your approval) in writing. And don’t forget to leave enough balance in the company’s business bank account to cover other liabilities, such as corporation tax.
Note thatyou can find yourself with an accidental directors’ loan if you try todistribute a dividend without enough profits in the company to declare one.
HMRC hastough rules on repaying directors’ loans. You must repay the loan within ninemonths and a day of your company’s year-end. Fail to do this and you’ll have topay extra corporation tax at 32.5 percent of the loan.
Let’s say you borrowed £5,000 on 10th April 2018 and your company year-end is 31st October 2018. You’d have until 1st August 2019 to pay back the money.
That’s over15 months to repay your loan. If you don’t pay it within this timeframe, you’llhave to pay 32.5 percent of £5,000 — that’s £1,625 — over and above your corporationtax.
Repaymentis easy. Use a salary or dividend payment to move the money back into thecompany bank account.
Don’t take out another loan right after you’ve paid one off. HMRC sees this as a tax-avoidance tactic known as ‘bed and breakfasting’. The Government has rules to counteract this: the 30-Day Rule and the Arrangements Rule.
The 30-Day Rule
The 30-day rulekicks in when, in any 30-day period, repayments on the loan of at least £5,000are made to the close company. (That’s a company controlled by five or fewerparticipants — or any number if they’re all directors.)
This repayment must be followed by another amountof at least £5,000 being withdrawn by the same person in an accounting period afterthe one in which the loan was made.
The Arrangements Rule
The arrangements rule applies when the overdrawnloan account is at least £15,000. When it’s repaid, there must be arrangementsfor replacement withdrawal(s) by the same person of at least £5,000. The withdrawal(s)must then take place at any time after the repayment.
Note that ‘arrangements’ has a wide meaning in HMRC’s view (see the Company Taxation manual: CTM61635).
Does your limited company have to pay tax on your loan? That depends on when you repay it.
Any tax due isn’t strictly speakingcorporation tax. It’s called Section 455 CTA Tax. HMRC charges it at 32.5%. Inpractice, though, you do lump it in on the company tax return with any corporationtax that you owe.
Here are some examples:
1. You've settled your directors' loan by the end of your company's accounting period
Your firm won’t pay any tax on theloan. HMRC doesn’t need to know about it.
2. You settle the loan within nine months of your company’s year-end
Your company needn’t pay tax on thedirectors’ loan. But the company will need to itemise it in its tax return.
3. You repay in part within nine months of your company’s year-end
Your company will pay tax on thebalance. If the balance was £20,000 on 5th April 2017, and £10,000 on 5thJanuary 2018, you’d pay £3250 tax on the remaining £10,000.
4. You fail to repay anything within nine months of your company’s year-end
Failing to repay your directors’ loanby the nine-month deadline comes with some rather nasty tax implications.You’ll need to pay supplementary corporation tax (S455 tax) at 32.5 percent ofthe loan amount.
You’ll be entitled to reclaim this taxcharge. But only once you’ve repaid the full amount into your limited company.
We’re sure that when you take out adirectors’ loan, your plan is to pay it back.
But life can happen. A contract mightfall through. Or you might have a family emergency. And this could mean yourincome tumbling and a struggle to pay back the directors’ loan.
If you have enough money in your company’s business account, you could clear the loan account by declaring a dividend equivalent to the loan amount. This will deem the loan to be a dividend under the Income Tax (Trading and Other Income) Act 2005.
You can see where we’re going withthis. It’s a good idea to take out a directors’ loan only in an emergency.
In a ‘close company’, you must record‘private’ payments made to the director’s family, friends or associates. Youshould also note that lending money to friends doesn’t get you around theconsequences of an overdrawn director loan account.
Need a reminder of what a closecompany is? It’s one controlled by five or fewer participants — or any numberif they’re all directors.
Let’s say your company has twodirectors, who are spouses. One owes the company money and the other is owedmoney. To offset these balances, the husband and wife must set out the detailsin writing. It’s also vital to keep clear documentation.
The liquidator can make the directorrepay the amount owed so that creditors can be paid. This could result in legalaction or even bankruptcy.
So, should you take out a directors’loan or not? No one solution is right for everybody. As a rule, the worst-casescenario (apart from bankruptcy) – the S455 charge – is mostly harmless. That’sprovided you plan on repaying the loan quickly.
If, however, the overdraft lingers,you might find it better to declare dividends (if profits allow). You’llusually have to pay personal tax on these.
The good news is that this tax paymentwill be a one-off. That’s compared with the implications of an overdrawndirector's loan account, which can rumble on for years.
There’s no NIC to pay on dividends,too, so they’ll be a more cost-effective option.
In general, it pays to keep greatrecords if you’re relying on a directors’ loan account.
Bad records could mean expenses andpayments being misallocated and inaccurate payment of taxes.
Another good reason for accuraterecord-keeping is that you must disclose the balance on each loan account atyear-end in your accounts. That, and the highest overdrawn balance of the loanat any point.
Directors’ loans can offer a handy wayof getting an interest-free loan, to help you through a very short-term stickypatch. Handled badly, though, they can turn into a tax-heavy nightmare, or muchworse. Good luck, and tread carefully.