FAQ: What is a director’s loan? How does one work and what are the tax implications if I take a director’s loan from my limited company?
A frequently asked question from our clients relating to their limited companies is “what is a director’s loan?” Our clients often wonder whether they may be penalised for withdrawing a director’s loan from their business bank account.
Our blog will help answer this question and provide detailed advice. Find out what a director’s loan is and how you go about withdrawing a director’s loan. Most importantly, you’ll learn about the implication on your finances of doing so.
Director’s loan – what is it?
The Government’s website defines a director’s loan as follows:
“A director’s loan is when you (or other close family members) get money from your company that isn’t:
- a salary, dividend or expense repayment
- money you’ve previously paid into or loaned the company”
Every company has a figurative ‘director’s loan account’ which will remain at 0 until you withdraw one. If you take a director’s loan, you will then have what’s called an ‘overdrawn’ director’s loan account.
Who can take out a director’s loan?
You may require a loan for a number of reasons, such as financing a house purchase. As a limited company director, you can take out funds from the company. However, any money taken from the business bank account – aka the director’s loan account – not relating to salary, dividends or expense repayments will be classed as a director’s loan. This should be considered before you think about withdrawing funds.
Director’s loans must have approval from the company shareholders, particularly loans of more than £10,000. As contractors are usually the sole director and shareholder of their own company, this is quite simple to do.
Director’s loans should be recorded and signed off on board minutes. You should also ensure that you leave sufficient funds in your business account to cover other company liabilities, such as Corporation Tax.
How do you withdraw a director’s loan?
Director’s loans are withdrawn when company money is taken from the business bank account without declaring dividends or paying salary. Some contractors may unknowingly end up with a director’s loan in this way. For example, if they try to distribute a dividend when there are not enough profits in the company, this results in a director’s loan.
When to repay your director’s loan
HMRC has strict rules on director’s loans. It is important to note that loans must be repaid within nine months and one day of the company’s year-end. Failure to repay the loan within this timeframe will result in tax implications – at a rate of 32.5% on any outstanding amount.
You borrow £5,000 on 10th May 2019 and your company year-end is on 30th November 2019. Therefore, you will have until 31st August 2020 to repay the loan. That is just over one year and three months to repay the director’s loan. If you choose to withdraw one, you need to ensure that you can repay the loan amount within HMRC’s timeframe.
How to repay your loan
To repay the director’s loan you withdrew from your limited company, simply transfer the money back into the company bank account. Alternatively you can credit the figurative director’s loan account with a salary or dividend payment.
We advise that you do not take out a director’s loan immediately after repaying another. HMRC may see this as a tax avoidance tactic called ‘bed and breakfasting’. HMRC has rules to counteract this; for more details please contact us and we will be happy to advise further.
Implications of taking out a director’s loan
Failing to repay the loan amount by the deadline will result in tax implications for your company. Outstanding loan amounts that are not repaid will be subject to a supplementary Corporation Tax charge, known as S455 tax. This comes at a rate of 32.5% for loans taken from 6th April 2016, payable to HMRC.
S455 tax can be reclaimed, but only when the full amount has been repaid into the limited company. Refunds can be a lengthy process and could take years to meet the eligibility criteria.
If you owe your company £10,000 or more in the form of a director’s loan you should also consider this:
- It will class as a benefit in kind or ‘beneficial loan’ as it is essentially an interest-free loan
- It will need to be recorded on your company’s P11D
- You will also need to record the cash equivalent of the director’s loan on your Personal Tax Return. The cash equivalent value of a director’s loan is based on HMRC’s official rate of interest for beneficial loans. For the 2019/20 tax year this is 2.50%.
Income tax and National Insurance will be due on the cash equivalent value of the loan. For example, if you had a loan of £15,000, the cash equivalent of the director’s loan would be £375. Class1A National Insurance due on the loan, at a rate of 13.8% of the cash equivalent value, would be £51.75. The personal tax liability for a basic rate taxpayer would be 20% of the cash equivalent value, or £75.
You can potentially avoid these tax liabilities by paying the interest on your loan equal to or above HMRC’s rate. Using the previous example of the £15,000 director’s loan, this would mean paying the cash equivalent of £375 in tax.
Is it possible to clear a director’s loan if it cannot be paid back?
Most directors who take out a director’s loan have good intentions to pay it back. However life circumstances can arise, including not being able to find a new contract, sudden contract termination or personal emergencies. In this case, company profits may fall and the director may not be able to pay back the loan.
It is still possible for a company to clear an overdrawn director’s loan account, or ‘release’ the loan. This is done by distributing a dividend if there are funds available in the company’s business account. However this is not necessarily advised as if this action is taken, the loan will be deemed a dividend.
In this case, HMRC may seek NI Contributions. It could argue the company was in fact providing salary or compensation to the director who received the director’s loan.
A company is also not able to receive Corporation Tax relief on a cleared director’s loan in this way.
Think carefully before taking a director’s loan
As you can see, dealing with director’s loans can get very complicated very quickly. Seeking the advice of a UK contractor accountant will help you make a fully informed decision. Plus if you appoint a specialist contractor accountant, they can help you navigate the implications of a director’s loan.
If you are a client and would like to find out more, speak to our Personal Tax team on email@example.com.
Not a client but would like some advice on director’s loans or setting up a contractor business? Contact us on 01707 871622 or email firstname.lastname@example.org and find out more about our limited company accounting services.
Churchill Knight provides contractors with quick, easy and hassle-free limited company accounting. Whether you are comfortable with handling company admin yourself or want a completely hands-off service, we have accountancy options for you.
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Last updated 7th March 2019.