As a limited company director, you can access the money in your company bank account through a facility known as a director's loan.
This can come in handy in instances when your personal finances are in need of a boost, yet taking out a director's loan is a decision that requires careful consideration. That's because there are tax and accounting implications, and it's best to speak to an accountant beforehand so that you fully understand the consequences.
Understanding the basics of director's loans
What is a director's loan?
According to HMRC, a director's loan is defined as money taken from your company that isn't either of the following:
- A salary, dividend or expense treatment
- Money that you've previously paid into or loaned the company
What is a director's loan account?
A Director's Loan Account (DLA) is a record of all transactions between the company and its directors. It records not just the money owed by the directors, but also the money owed to them.
At the end of the financial year, the amount is recorded in the balance sheet either as an asset (money is owed by the director) or liability (money is owed to the director).
Who can take a director's loan?
As the name suggests, only directors of a company can take out a director's loan.
Can I loan money to my company?
You're also able to make a director's loan to your company. This may take place when a director wants to provide funding for the company's activities or for an asset purchase, but only on a short-term basis.
The loan may be made to the company with or without interest.
If interest is charged, this will be considered a source of income for the director, and must therefore be recorded on the director's Self Assessment tax return. Interest paid to the director is considered a business expense for the company.
What should a director's loan account contain?
A DLA should contain:
- Cash withdrawals and repayments made by its directors
- Personal expenses paid with company money or a company credit card
- Interest charged on the loan
What are director's loans used for?
You can draw your earnings as director's loans, and convert them to dividends and salary at a later point in time.
Director's loans are also used when you need to access money in your company - apart from what you take out as a salary, dividend or expense treatment - for personal reasons.
The money can be used for a variety of purposes, such as covering the costs of a home repair bill, travel plans or any unforeseen personal expenses that may arise – but these should be paid personally using the funds from the Loan taken from the company – and not paid directly from the company bank account.
Is a director's loan a benefit in kind?
A director's loan is considered to be a benefit in kind if the following conditions apply:
- The loan amount is £10,000 or more
- You're not paying interest on the loan
- The interest you're paying on the loan falls below HMRC's average official rates for beneficial loan arrangements
If these conditions are met, you're required to report and pay taxes on benefits.
You'll need to record the loan on a P11D form and on your Self Assessment tax return. Personal taxes may be due, and your company may pay National Insurance Contributions at a rate of 15.05% on the determined value of the benefits.
Is it only transactions with the directors that need to be recorded?
No, if the company is a close company any ‘private’ payments made by the company to a director’s family, friends, business partner or any person associated with the director may need to be recorded. Also, an overdrawn director loan account cannot be avoided by lending money to a person connected with the director. A close company is one that is controlled by five or fewer participators or by any numbers of participators if those participators are the directors of the company.
Can an overdrawn DLA be offset?
There might be situation where the company has two directors (eg husband and wife) and one director owes money to the company, while the other is owed money. In order to be able to offset these balances, the directors must formally agree in writing (and proper documentation should be kept) before any offsetting takes place.
You or your company may have to pay tax on a director's loan, depending on the length of time that you've borrowed the money for, as well as the amount you've borrowed.
Length of time
You'll need to repay the loan within nine months and one day of your company's year-end.
If you're not able to do so, your company will be required to pay a Corporation Tax charge (known as s.455 tax) at a rate of 33.75% on the outstanding amount.
1. You repay the entire loan within nine months and one day of your company's year-end
Your company won't pay any tax on the loan.
Here's an example: if you've taken out a loan on 15th March 2021, and the amount is still outstanding at your company's year-end of 31st March 2021, you'll need to repay the loan by 31st December 2021 to avoid paying additional tax.
2. You repay a portion of the loan within nine months and one day of your company's year-end
Your company will be required to pay tax on the outstanding balance.
If the unpaid balance of the loan is £2,500, you'll pay additional Corporation Tax amounting to £843.75 (33.75% of the outstanding amount).
3. You fail to repay the loan within nine months and one day of your company's year-end
Let's say you've taken out a loan of £5,000 on 15th March 2021, and the amount is still outstanding at your company's year-end of 31st March 2021.
If this isn't repaid by 31st December 2021, you'll need to pay additional Corporation Tax totalling £1,687.50 (33.75% of the outstanding amount).
Reclaiming Corporation Tax
s.455 is considered a temporary tax, so it can be reclaimed once you've paid off the outstanding loan balance.
Do note that the repayment isn't immediate; the tax is repayable nine months and one day after the end of the accounting period in which the loan is repaid. Any interest charged on the Corporation Tax can't be reclaimed.
Your claim must be made within four years. The processes and documents for making a claim will differ depending on whether you're reclaiming within two years, or after two years of the end of the accounting period where the loan was taken.
The amount borrowed
There isn't a limit to the loan amount that can be taken out.
However, if the loan amount exceeds £10,000, your company will need to treat the loan as a benefit in kind and deduct Class 1 National Insurance.
You'll need to report the loan on your Self Assessment tax return, and may have to pay tax on the loan at the official rate of interest.
What are the consequences on the overdrawn DLA if the company goes into liquidation?
The liquidator can demand that the director repays the amount owed to the company in order to pay the company’s creditors. The liquidator can take legal action against the director or even make him bankrupt.
In conclusion, when the director borrows money from the company, good record-keeping is essential to ensure the right taxes are paid. The director should be aware that if too much money is borrowed and the company is unable to pay its creditors, the company might be forced into liquidation and the liquidator can take legal action against him to reinforce the debt.
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