Updated 03 December 2020
Should I borrow money from my company by taking out a director’s loan? Or should I loan money to my company? Both of these questions may arise from time to time when you are a company director. To answer them, you’ll need to understand what is mean by a director’s loan, how your director’s loan account works, and the responsibilities and risks involved when borrowing or lending money in this way.
A director’s loan is money you take from your company's accounts that cannot be classed as salary, dividends or legitimate expenses. To put it another way, it is money that you as director borrow from your company, and will eventually have to repay.
Another kind of director’s loan is when a director lends money to the company, for example to help with start-up costs or to see it through cash flow difficulties. As a result the director becomes one of the company’s creditors.
Taking out a director’s loan can give you access to more money that you are currently receiving via salary and/or dividends. Director’s loans are typically used to cover short-term or one-off expenses, such as unexpected bills. However, they are admin-heavy and come with risks (such as the potential for heavy tax penalties), so they shouldn’t be used routinely, but rather kept in reserve as an emergency source of personal funds.
The director’s loan account (DLA) is where you keep track of all the money you either borrow from your company, or lend to it. If the company is borrowing more money from its director(s) than it is lending to it, then the account is in credit. However, if the director(s) borrow more, then the DLA is said to be overdrawn.
Be aware that shareholders (and perhaps other creditors) may become concerned if your DLA is overdrawn for any length of time. You should aim to ensure that most of the time it is either in credit or at least at zero. Find an accountant for your small business who can help with putting together a director’s loan account.
It is up to your company what interest rate it charges on a director’s loan. However, if the interest charged is below the official rate then the discount granted to the director may also be treated as a ‘benefit in kind’ by HMRC. This means that you as director may be taxed on the difference between the official rate and the rate you’re actually paying. Class 1 National Insurance (NI) contributions will also be payable at a rate of 13.8 per cent on the full value of the loan.
There is no legal limit to how much you can borrow from your company. However, you should consider very carefully how much the company can afford to lend you, and how long it can manage without this money. Otherwise the director’s loan may result in cash flow problems for your company.
Also bear in mind that any loan of £10,000 or more will automatically be treated as a ‘benefit in kind’ (see above) and must be reported on your self-assessment tax return. In addition you may have to pay tax on the loan at the official rate of interest. For loans of £10,000 or more you should seek the approval of all the shareholders.
A director’s loan must be repaid within nine months and one day of the company’s year-end, or you will face a heavy tax penalty. Any unpaid balance at that time will be subject to a 32.5 per cent corporation tax charge (known as S455 tax). Fortunately, you can claim this tax back once the loan is fully repaid – however, this can be a lengthy process.
If you have taken longer than nine months and one day to repay your director’s loan and have been charged corporation tax on the unpaid amount, you can claim this tax back nine months after the end of the accounting period in which you cleared the debt. This is a long time to wait and the process can be onerous, so it’s best to ensure you don’t end up in this position.
One possible workaround is to put off paying your company’s corporation tax until your director’s loan is repaid. Your corporation tax payment deadline is nine months after your financial year end, which can give you extra time to repay the loan.
You have to wait a minimum of 30 days between repaying one loan and taking out another. Some directors try to avoid the corporation tax penalties of late repayment by paying off one loan just before the nine-month deadline, only to take out a new one. HMRC calls this practice ‘bed and breakfasting’ and considers it to be tax avoidance. Note that even sticking to the ’30-day rule’ is not guaranteed to satisfy HMRC that you are not trying to avoid tax. This is why you shouldn’t make a habit of relying on director’s loans for extra cash.
It is even possible to take out a director’s loan inadvertently, by paying yourself an illegal dividend. As director you may choose to take much of your income in dividends, as this is generally more tax efficient than a salary. However, dividends can only be paid out of profits, so if your business has not made a profit then legally no dividends can be paid.
If you don’t take enough care in preparing your management accounts, then you may declare a profit by mistake and pay yourself a dividend. This illegal dividend should then be considered to be a director’s loan, and recorded in the DLA. You should then make sure to repay it within the nine-month deadline.
It’s possible to make a director’s loan the other way round, by lending to your company. This may be an option for you if you want to invest money into your company (e.g. to fund its ongoing activities and/or buy assets) but only a temporary basis.
If you decided to charge interest, then any interest that the company pays you is considered income and must be recorded on your self-assessment tax return. The company treats the interest paid to you as a business expense, and must also deduct income tax at source (at the basic rate of 20 per cent). However the company will pay no corporation tax on the loan.
Here is a short summary of things to remember if you are considering borrowing money from your company or lending to it.
As you can see, director’s loans are a tricky area, so should not be used lightly or routinely. Strict bookkeeping and accounting is also extremely important when dealing with director’s loans, so make sure you are using a good accountant.
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