If you’re a director & contractor and run your own limited company, you may at some point have a UK contractor director’s loan account (DLA). 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. On the other hand, a situation may arise where you may look to borrow money from your company. When this occurs, it’ll be in the form of a company loan to director. In both scenarios, there’s a limited company contractor director loan and this’ll show on the company Balance Sheet. Therefore, to summarise, a director account in terms of an advance from either party could be:
- A company loan from director.
- A loan from company to director.
The reason for a director borrowing through a contracting business can emerge due to an array of reasons. If a director does borrow from their company, this is a 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 guide, 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.
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 account (DLA)
When you run your own limited company, your director’s loan (limited company) 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 loan could be an ongoing issue. Indeed, there could be a balance owing, one way or another, on an ongoing basis. Therefore, this’ll show in your company accounts as director contractor loans to or from your company. Therefore, in this guide, we’ll cover a DLA for a UK contractor and look at 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, we’ll consider all the above in this guide. In addition, we’ll look at the beneficial loan interest calculation as well as an alternative more tax efficient method. In this different method, you won’t not need to pay tax on the loan interest.
Contractor loan and a 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 loan?
When you’re the sole director of your company, there’s no need for a director’s loan agreement in writing. However, if you’re 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 contractor director’s loan to company
When you lend money to your company, this is a loan to your 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 you decide that the company will pay you interest on the loan from director to company, it’s up to the two parties to decide on the interest rate. However, the interest on any director’s loans to a company will become taxable income in a personal tax context for the director. If you’re the sole director of your company, there’s no real benefit to paying any interest on director loan to company.
Ltd company loan to director
From a technical standpoint, under the Companies Act 2006, it isn’t 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 loan can arise where you take money from the company that isn’t 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 DLA -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 in relation to what you owe back to your company on a contractor director’s loan relates to your personal tax. Here, there’s a temporary advance of funds to an employee who’s also the director. This scenario only applies where the amount of the loan from the company is more than £10,000. If the loan exceeds £10,000 at any time in a tax year, there’s a tax implication by way of 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 DLA. 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 hasn’t 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’ll 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) on the interest. We’ll calculate this at a rate of 14.53% in 2022/23 and 13.8% in 2023/24 on the same amount of interest. In addition, the Class 1A NI is payable once per year. Indeed, it’s due by 19 July after the previous 5 April.
As a director, if your business makes a temporary advance of funds to your spouse, HMRC will treat the loan as though it was to you. They’ve already thought of this one.
The tax-efficient way to deal with a loan to a company director
There is a more tax-efficient way to deal with an overdrawn DLA. 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 DLA for the period which it was overdrawn during the tax year. When the contractor pays their company the interest on the loan, there’s no benefit in kind. As a result, there’s no need to report the beneficial loan interest on the overdrawn DLA on form P11D.
How the tax-efficient alternative way works
As we mention earlier, the current HMRC interest rate on a contractor director’s loan is 2.25%. In addition, the personal tax on the overdrawn DLA interest is a cost to the director. However, when the director pays interest on their director’s overdrawn loan account to the company, it’ll 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 (please see our Corporation Tax guide for details).
When you compare the interest on the loan and P11D methods, there’s 14.53% or 13.8% Class 1A NI, which is payable by the company. In addition, there’s income tax, that’s payable by you as the director and you’ll pay this either at 0% or more likely 20%, 40% or 45%. Therefore, when there’s a DLA which the company director owes, it’s much more tax-efficient for your company to charge the director interest.
Contractor DLA -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’s 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) won’t repay the loan within nine months and one day of the financial year.
- If the DLA 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 loan is repaid within nine months and one day of the company’s year-end, the company won’t not owe any tax.
- Any part of the loan that you don’t repay within nine months is subject to Section 455 Tax. We calculate the S455 Tax is 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’ll be no tax charge.
In addition, there can be further potential tax consequences. This occurs when there’s a loan from one of your previous accounting periods which you don’t repay by the end of the current year. Where there’s a loan due at the end of your last financial year which you don’t fully reimburse by the end of the current year and Section 455 tax hasn’t been paid on this previously, there’s a Section 455 charge due on that balance now. The Section 455 tax is reportable on form CT600A which is a supplementary form to your company’s Corporation Tax return.
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 borrow from their company will attempt to repay this within nine months of their company year-end.
It’s 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 DLA to your company.
When a director doesn’t repay the DLA 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’re 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 don’t draw the actual cash in relation to this. In turn, this’ll 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 limited company loan to director if the director repays the outstanding DLA 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’ll 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 DLA 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 DLA 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 DLA repayment ineffective, where the director will borrow funds again within 30 days. It also doesn’t 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’s company loans to directors.
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 DLA repayment to repay the loan in full by 31 December 2023. Therefore, there’s no S455 Tax payable.
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 DLA decreases to £4,000 due to a DLA repayment of £2,000 during the year.
In this example, she doesn’t repay the company loan 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.
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 DLA 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’s 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 won’t 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 DLA 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 great contractor accountant to guide you, they can ensure that the tax on director’s loans is reported, paid, and recovered correctly.
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’s key to consider the guidelines above regarding 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’s 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’re still unsure and have a good contractor accountant, they’ll help you understand and guide you through the above.
Link to Contractor Advice UK group on