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Introduction -what is a director’s loan account?
If you’re a director & contractor of a limited company, you may at some point have a UK contractor director’s loan account. Indeed, this could arise if you need to lend money to your UK contracting company because it needs to pay some future bills. As a limited company contractor, when you lend to your business, this is a loan from director to company. Alternatively, a situation may arise where you may look to borrow money from your company. Once again, this will be in the form of a limited company contractor director loan. Therefore, to summarise, a director account in terms of a loan could be:
- A company loan from director.
- A loan from company to director.
The reason for a limited company loan to director through a contracting business can emerge due to an array of reasons. If a director borrows from their company, this is a ltd company loan to director. Basically, if either of the above two scenarios arise, the amount you lend or borrow will be a contractor director’s loan. What’s more, another term for this is a director’s current account. Therefore, how does a director’s loan work? In this article, we’ll look into this and how the contractor limited company director’s loan repayment rules work. In addition, we’ll consider accounting for director’s loans as well as the overdrawn director’s loan account interest rate and the tax on director loans.
Initial thoughts
What to consider first
The total amount of any limited company loan between you as the director, and the company, will be shown in the form of a loan account. When you’re a UK contractor, you can view this as your limited company contractor director’s loan account.
A director’s loan (limited company)
When you run your own limited company, the loan account will show as a balance in your company’s Balance Sheet. In normal circumstances, the contractor limited company director loan will be repaid in the future. However, such a director loan could be an ongoing issue. Indeed, there could be a balance owing, one way or another, on an ongoing basis. Therefore, this will show in your company accounts as director contractor loans to or from your company. Therefore, in this guide, we’ll cover a contractor limited company director’s loan (UK) and the considerations around this.
Some common questions
Some common questions, from contractors around a contractor loan to or from their company, will likely include:
- How do director’s loans work?
- How do director’s loan accounts work?
- Can a director loan money to his company?
- Can I take a director’s loan from my company?
- How many director’s loans can I take?
- What is an overdrawn director’s loan account?
- How to calculate interest on director’s loan account?
- How to calculate interest on overdrawn director’s loan account?
- What is director’s loan account on a Balance Sheet?
Therefore, let’s consider all of the above in this article. In addition, we’ll also look at the beneficial loan interest calculation as well as an alternative more tax efficient method. In this different method, you will not need to pay tax on the loan interest.
Initial considerations
Contractor director’s loan account -director loan agreement
In both cases, either a loan from or to the company, is there a need for a written agreement? Indeed, in the case of limited company contractors, do they need an official agreement in writing for their director loan?
Where you are the sole director of your company, there is no need for a director’s loan agreement in writing. However, if you are part of a company with more than one director, a loan agreement between director and company can be put in place. This is due to the fact that other parties are in your business.
A director’s loan to company
When you lend money to your company, this is a director loan to company. Basically, the loan to company from director could be on a short-term basis. Indeed, this could be due to a temporary cash shortfall due to upcoming bills or other costs. In the future, the business can repay the director’s loan to limited company. Of course, this is once a business has the funds available and is in the position to repay a director’s loan to a company. To sum up, the loan from director to company will form part of your company’s Balance Sheet if you don’t repay it by the company year-end. There is also no time limit in respect of when a company has to repay a director loan. Basically, the director can agree with their company when it should repay them.
The company can also pay you interest on director’s loan to company. When a company is paying interest on director’s loan accounts, the cost of the interest is a business expense. In addition, if it is decided that the company will pay you interest on the loan from director to company, it is up to the two parties to decide on the interest rate. However, the interest on any director’s loans to a company will also become taxable income in a personal tax context for the director. If you are the sole director of your company, there is no real benefit to paying any interest on director loan to company.
Company loan to director
From a technical standpoint, under the Companies Act 2006, it is not allowed for companies to make a loan to a director or shareholder. This is unless you obtain the shareholder’s approval first for a director’s loan from company.
However, many UK contractors who run their own company will always borrow money from their companies. Essentially, a company loan to director can arise where you take money from the company that is not either:
- A salary, dividend or expense repayment.
- A repayment to the company of a previous loan to the director.
When it comes to how much can a director borrow from the company there’s no actual limit as such. However, you must ensure that you repay this in the future.
A loan to a director can be quite a complex area. If you prefer an accountant who has knowledge in subjects such as this, please read how to change your accountant.
The two tax effects for a loan to a director
HM Revenue & Customs (HMRC) have two potential tax implications which connect with loans to directors.
Contractor director’s loan account -tax effect 1 -P11D item -NI for the company and tax for the employee
A loan to a director from their company
The first tax effect relates to your personal tax. There is a loan to an employee and in this context, it is a director is an employee. This scenario only applies where the amount of the loan from the company is more than £10,000. Indeed, it should not exceed this level at any time in a tax year. However, if it does exceed this level there is a tax implication.
Such a loan to the director will be a benefit in kind. As a result, you must report these on the PAYE year-end form P11D. What’s more, the employer must calculate the `beneficial loan interest’ on your director’s loan. You also need to report the interest on overdrawn loan account on form P11D. Furthermore, you must also report any benefits in kind on your Self-Assessment tax return each year.
The HMRC beneficial loan interest rate
The beneficial loan interest is the interest on the overdrawn director loan account that the director or borrower has not yet paid the employer. This interest is the taxable benefit in kind. You can use the director loan interest rate that HMRC publish. The current HMRC beneficial loan rate or HMRC director’s loan interest rate in use is 2.25% and you must also report the loan interest benefit on your Tax Return.
The beneficial loan interest calculation and personal taxes
Let’s now consider how to do the beneficial loan interest calculation:
- If your loan is £10K overdrawn at the start of the tax year and then £20K overdrawn at the end of the year, the average balance is £10K + £20K = £30K / 2 = £15K. Therefore, the interest is £15K x 2.25% / 12 months x 12 months (as it was overdrawn for the full year) = £338.
- If your loan became overdrawn during the tax year in month 7 (October) and was £20K overdrawn at the end of the year, the average balance is £0K + £20K = £20K / 2 = £10K. Therefore, the interest is £10K x 2.25% / 12 months x 6 months (as it was overdrawn for six months) = £113.
Dependent upon your overall personal income, you will pay personal tax on the interest benefit at either 0%, 20% or 40% or 45%.
Furthermore, the employer will pay Class 1A National Insurance (NI). We will calculate this at a rate of 14.53% in 2022/23 and 13.8% in 2023/24 on the same calculated interest. In addition, the Class 1A NI is payable once per year. Indeed, it is due by 19 July after the previous 5 April.
As a director, if your business makes a loan to your spouse, HMRC will treat the loan as though it was to you. They have already thought of this one.
The tax-efficient way to deal with a loan to a company director
There’s a more tax-efficient way to deal with a contractor director’s loan. This is an alternative to declaring interest on beneficial loans on form P11D. Basically, the method here is a company can charge director’s loan account interest to the director. You calculate interest on the overdrawn director’s loan account for the period which it was overdrawn during the tax year. When a director pays their company the interest on the director loan, there’s no benefit in kind. As a result, there is no need to report the beneficial loan interest on the overdrawn director’s loan account on form P11D.
How the tax-efficient alternative way works
As we mention earlier, the current HMRC interest rate is 2.25%. In addition, the personal tax on the overdrawn director’s loan account interest is a cost to the director. However, when the director pays interest on their director’s overdrawn loan account to the company, it will become extra income for the company. As a result, this extra income in the company accounts will increase the bottom-line profit. Consequently, this extra profit is payable as dividends to the director.
Under this scenario of a director paying the company interest on overdrawn director’s loan account, the tax cost is the 19% Corporation Tax (CT) on the interest up to 31 March 2023. However, from 1 April 2023 your company will pay CT at either 19% or 25%, depending on whether your company is small or large (see our Corporation Tax guide for details).
When you compare the interest on the loan and P11D methods, there is 14.53% or 13.8% Class 1A NI, which is payable by the company. In addition, there is income tax, that is payable by you as the director and you will pay this either at 0% or more likely 20%, 40% or 45%. Therefore, when there is a loan to a company director, it is much more tax-efficient for your company to charge the director interest.
Contractor director’s loan account -tax effect 2 -Section 455 Tax
Company loan to shareholder
The alternative to a loan to a director is a loan to a shareholder. This is effectively a temporary director’s loan tax on the value of the loan.
Therefore, there is a tax effect when:
- The company will make a loan to a shareholder (who in this case is also a director) in the financial year; and
- Where the shareholder (director) will not repay the loan within nine months and one day of the financial year.
In summary:
- If the loan account is overdrawn (the director will owe the company money) at the company’s year-end, the company may need to pay tax.
- However, if the entire director’s loan is repaid within nine months and one day of the company’s year-end, the company will not owe any tax.
- Any part of the director’s loan that you do not repay within nine months is subject to Section 455 Tax. The S455 Tax is calculated at 33.75% of the outstanding balance.
- The S455 Tax rate was 32.5% before 6 April 2022. Before 6 April 2016, the S455 rate was 25%.
Contractor director’s loan account –Section 455 Tax and how this works
If your loan account is overdrawn by 30 April 2023, you must repay this by 1 February 2024. If you repay the loan by this date, there will be no tax charge.
In addition, there can be further potential tax consequences. This occurs when there is a loan from one of your previous accounting periods which you do not repay by the end of the current year. Where there is a loan due at the end of your last financial year which you do not fully reimburse by the end of the current year and Section 455 tax has not been paid on this previously, there is a Section 455 charge due on that balance now.
As we set out above, the S455 Tax charge is now 33.75% of the appropriate loan amount. Out of interest, the rate of S455 charge is exactly the same as the higher rate tax on dividends. Presumably, the rate is set at this level to sway company directors from considering taking a loan for an extended time period. Therefore, many directors who take a loan will attempt to repay this within nine months of their company year-end.
It is important to be aware that Section 455 Tax is refundable to your company in the future. Basically, HMRC will make a S455 repayment nine months after the financial year, during which you repay your contractor director’s loan to your company.
When a director does not repay the loan in time, the company will pay Section 455 Tax. Therefore, in between paying the tax and subsequently recovering this from HMRC, the company has tantamount lent the amount of tax to the Government.
How to repay director’s loan
When you are ready to make a director’s loan repayment and repay part or all of the loan, you can either:
- Repay the money into your company bank account; or
- Allocate a salary or dividend payment against the loan. i.e., record a salary payment or dividend as taxable income but do not draw the actual cash in relation to this. In turn, this will reduce or clear the loan balance.
Contractor director’s loan account -avoid a Section 455 tax charge
A company can avoid the Section 455 charge on a company loan to director if the director repays the outstanding loan balance before the corporation tax due date. This date is nine months and one day after your company’s year-end.
Director’s loans rules
There are some anti-avoidance rules which are in place. Indeed, it will help if you take care not to fall foul of these director’s loan rules. These rules will seek to ensure that any repayments of the contractor director’s loan are genuine repayments, as opposed to transactions which are designed to avoid the Section 455 Tax charge. Such transactions include when you take out another loan very shortly after you had just repaid it.
Of the director’s loan rules, the main rule is a 30-day rule. This comes into play within 30 days when the director repays £5,000 or more. However, the director then decides to borrow from the company again (this is known as ` bed and breakfasting’). This rule will render the director’s loan repayment ineffective, where the director will borrow funds again within 30 days. It also does not matter which comes first, the actual loan repayment or the further loan one takes; the 30-day period will apply equally. This measure will prevent a director from deciding to take out a new loan and use it to repay all or part of the original loan.
Contractor director’s loan account examples
Let’s now look at some contractor examples where there are company loans to directors.
Example 1
John is a limited company contractor and he owes his company £6,000 as of 30 June 2023. He originally took his contractor director’s loan in the year to 30 June 2022. John then makes a director’s loan repayment to repay the loan in full by 31 December 2023. Therefore, there is no S455 Tax payable.
Example 2
Zoe is a UK contractor and owes her company £6,000 as of 30 September 2023. Previously she said she will repay this within nine months of the 2023 year-end. At the next company year-end (30 September 2024), Zoe’s contractor director’s loan account decreases to £4,000 due to a director’s loan repayment of £2,000 during the year.
In this example, she does not repay the company loan to director in full as of 30 September 2024. Therefore, Zoe’s company now needs to pay 33.75% (£1,350) of the £4K over to HMRC.
If Zoe will repay the balance of £4K to the company by 30 September 2025, the £1,350 will be refundable to her company on 30 June 2026.
Example 3
Peter has his own contractor limited company and he owes his business £10,000 as of 31 December 2022. Subsequently, his company paid over 33.75% of this (£3,375) as S455 Tax. His contractor director’s loan will increase to £15,000 by 31 December 2023. Peter anticipates making a director’s loan repayment of £10K by 30 September 2024. Therefore, his loan with the company will decrease to £5,000 by 30 September 2024.
In this scenario, there is no S455 charge due for the December 2023 year. Basically, the reason for this is because Peter repays the loan of £5,000 which he takes in the December 2023 year, within nine months of the year-end.
The outstanding loan balance as of 30 September 2024 is £5,000. Therefore, a further £5,000 of the loan is repaid in connection with the December 2023 year. This £5,000 will not receive S455 Tax relief, as the original £10,000 loan that Section 455 tax was paid on relates to the previous year. Instead, the company needs to wait and see the position as of 31 December 2024. If Peter repays the loan in full or it reduces from the previous balance of £10,000, the appropriate amount of S455 Tax will be refundable by 30 September 2025.
There are also further variations of the above examples, which can leave one mystified. If you have a good contractor accountant to guide you, they can ensure that the tax on director’s loans is reported, paid, and recovered correctly.
Final thoughts
When you run your own company, there can be a) loan from director to company or b) a loan to a shareholder or director in one of your accounting periods. However, in scenario b) the borrower may be both of these. In this case, both tax consequences can apply.
It is key to take into account the guidelines above with regard to a company loan to director. If you borrow from your company, please aim to repay this within nine months of the company year-end. When you have a contractor director’s loan for an extended period of time, please pay your company interest. When you do this, it is much more tax-efficient when you compare this to declaring interest on form P11D and paying tax on overdrawn director’s loan account.
If you are still unsure and have a good contractor accountant, they will help you understand and guide you through the above.
Link to Contractor Advice UK group on
