The tax rules associated with borrowing money from your own limited company are fairly complicated. Therefore, it is important for company directors to understand the rules, guidelines, and tax implications associated with taking out a Director’s Loan.
Director’s Loans can trigger additional tax if not handled correctly. If a loan is not repaid within nine months of your company’s year-end, a Section 455 tax charge may apply, along with potential Benefit in Kind implications.
In this blog, Kerry Newman, Head of SG Accounting looks at what a Director’s Loan actually is, what Limited Company contractors need to know, and potential problems you need to be aware of.
If you’re unsure how this fits with your wider remuneration strategy, see our guide to salary vs dividends or Corporation Tax.
What is a Director’s Loan?
A Director’s Loan is money taken from the company that doesn’t fall into the categories of salary, dividends, or expense repayments. Any such withdrawals must be recorded in the director’s personal Director’s Loan Account (DLA).
Who can take a Director’s Loan?
Director’s Loans are typically taken by company directors, who are often also shareholders (participators) in small limited companies.
Why take a Director’s Loan?
Directors may need to take a loan for personal expenses or unexpected financial needs. However, these loans must be recorded in the Director’s Loan Account.
This is quite common in contractor companies where income can be uneven across the year.
What is a Director’s Loan Account?
This is a record of transactions (excluding salary and dividends) between the company and its directors. It includes cash withdrawals and personal expenses paid using company money or credit cards.
How to take a Director’s Loan
Approval from the company shareholders is usually required, especially if the loan exceeds £10,000. Written approval must be kept as a record.
When do you repay a Director’s Loan?
HMRC rules state that Director’s Loans must be repaid within nine months and one day of the company’s year-end in order to avoid additional tax charges. Your contractor accountant will be able to advise you on your company’s year end and when this date would be.
What are the associated tax implications?
Whether a Director’s Loan is taxable will depend on when it is repaid. If repaid within 9 months and 1 day of the company’s year-end, no additional tax is due.
Otherwise, a Section 455 tax charge may apply. Your accountant will be able to advise you on this based on your personal circumstances.
How to repay the loan
Repaying the loan can be done through a dividend payment or a salary payment to return the money to the company’s bank account.
Keep in mind that dividends and salary are themselves taxable, so this should be planned carefully.
What happens if you can’t repay the loan?
If you’re unable to repay the loan, you may face tax consequences or financial complications, particularly if the Director’s Loan Account remains overdrawn.
‘Bed and breakfasting’
It is a term used when you repay the loan before the year-end and take out another loan straight after. HMRC has a rule in place to prevent this, including a 30 day rule should the loan value exceed £10,000. Your accountant will be able to advise you further on this.
Is a Director’s Loan a Benefit in Kind?
If your loan exceeds £10,000 and is interest-free (or charged below HMRC’s official rate), then it may be considered a Benefit in Kind and will therefore be subject to tax.
HMRC monitoring
HMRC actively monitors Director’s Loans, especially if the accounts are regularly overdrawn. There’s a chance these loans may be viewed by HMRC as income rather than a genuine loan, and they could be subject to Income Tax and National Insurance.
Consider professional advice
Tax can be complex, especially if you’re not up to date with the latest legislation, therefore it’s always sensible to seek advice from an experienced accountant before considering a Director’s Loan.
Final thoughts
In summary, while Director’s Loans can be a useful financial tool, they come with legal and tax responsibilities that must be carefully managed to avoid potential penalties and complications. Directors should stay informed and consult with professionals as needed to ensure they remain compliant.
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