There may be a time when you need to borrow money from your own limited company – perhaps to finance a house deposit, or for a major purchase. Here we look at how director’s loan accounts are treated, and how you could face a hefty tax bill if you don’t plan any cash advances properly.
Director’s Loans – 3 taxes to consider
There are three potential taxes to consider when looking at how director’s loans work; Section 455 tax on the overdrawn loan (Corporation Tax), higher rate tax on a dividend (Self Assessment) and a benefit in kind on a director’s loan (PAYE).
Here, Patrick Gribben from Intouch Accounting takes a look at each in turn…
1. Corporation Tax
Any loans to directors (and shareholders) outstanding at the balance sheet date (your company’s period end) have to be disclosed in the accounts and on the company tax return.
If they are not repaid within 9 months of the accounting period end then the company will pay extra Corporation Tax of 32.5% of the loans taken out after 6 April 2016 (or 25% on loans taken before 6 April). This extra 32.5% is repayable to the company by HMRC when the loan is repaid to the company.
Co-incidentally this is the same rate as a higher rate dividend would be, but the difference is that S455 tax is reclaimable, whereas personal tax on a higher rate dividend is not (because the loan has to be repaid whereas you can keep the dividend).
You should avoid repaying a loan and then taking it out again soon after as it’s an obvious avoidance tactic HMRC call bed & breakfasting. They will see through it and tax it as if it had never been repaid. If loans are outstanding this can also delay your accountant filing the accounts until they are either paid, or you agree to the extra tax charge.
If you intend to take a loan then consider the date of the loan in order to get the maximum time before repayment becomes due. Borrowing money on the first day of your company year will give you 21 months, whereas borrowing money on the last day of your company year will give you just 9 months.
2. Personal Tax
Dividend income falling within the higher rate tax band are taxed at 32.5%. This can be mitigated to some degree if you make personal pension contributions or donations to charity, as they both increase your basic rate tax band and therefore allow more of your dividends to fall into the basic rate band. Careful planning of the exact date the dividend is payable can also help to spread dividends across tax years.
Any interest-free, or low interest loans, over £10,000 will result in a taxable benefit in kind, and you’ll pay tax on the deemed value of any interest you’ve saved.
Keep in mind this is the total value of money you owe the company, so if you take a loan of £10,000 and then overpay your wages by £2 then the loan is £10,002 and it becomes taxable. There is no benefit in kind if you pay interest to the company at 2.5% or above.
Loans can be a useful tool to bridge the timing gap between when cash is required and the taxable date for dividends. If you are likely to require cash towards the end of the tax year, and a dividend would be subject to high rate taxes, using a loan to provide cash and then repay that loan with a dividend in the late tax year postpones or removes the high rate liability.
Tax advantage of using a director’s loan
The tax liability on loans is payable by the company, whereas the tax on dividends is a personal liability met from the dividend.
For a net cash requirement of £6,750:
Dividend = £10,000, less the higher rate liability of £3,250 = £6,750 cash.
If the company lent £6,750 cash, the company pays £2,193.75 (32.5%) S455 tax. The total cost is £8,943.75, and less than the cost of taking a £10,000 dividend.
Although the loan is repayable in the short term you have reduced the cost of taking £6,750 cash from the company.