Contractor director's loan

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Introduction

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 lend money to your UK contracting company because it must pay some future bills. As a limited company contractor, when you lend to your business, it’s a loan from the director to the 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 the director. Both scenarios will show a limited company contractor director loan 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 the director.
  • A loan from the company to the director.

The reason for borrowing through a contracting business can emerge due to an array of reasons. If a contractor does borrow from the company, this is a company loan to the director. If one of the above two scenarios arises, the amount you lend or borrow is 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? This guide will research this and how a contractor limited company director’s loan repayment rules work. In addition, we’ll consider accounting for director’s loans, the overdrawn director’s loan account interest rate and the tax on director loans.

Initial thoughts 

First thoughts

The total amount of any limited company loan between you as the contractor and the company is shown as a DLA. Therefore, when you’re a UK contractor, you can view this as your limited company contractor director’s loan account.

What is 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 is repaid in the future. However, such a borrowing could be an ongoing issue. Indeed, there could be a balance owing, one way or another, on an ongoing basis. Therefore, that’ll show in your company accounts as DLA contractor loans to or from your company. Thus, 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 do you calculate interest on the director’s loan account?
  • How do you calculate interest on an overdrawn director’s loan account?
  • What is the director’s loan account on a Balance Sheet?

Therefore, this guide will consider all of the above. We’ll also examine the beneficial loan interest calculation and an alternative, more tax-efficient method. In this method, you don’t have to pay tax on the loan interest.

Initial considerations

Contractor borrowing & what is a director loan agreement?

Is there a requirement for a written agreement in both cases, whether a loan is from or to the company? Indeed, should limited company contractors have an official written agreement for their loan?

When you own a company, a written director’s loan agreement is unnecessary. However, if you’re part of a company with more than one director, a loan agreement can be put in place between the director and the company because other parties are involved in your business. 

Contractor director’s loan to a company

When you lend money to your company, this is a loan to your company. The director could loan to the company on a short-term basis. Indeed, this could be due to a temporary cash shortfall due to upcoming bills or other costs. The business can repay the director’s loan to a limited company in the future. 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 the director to the 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 when a company must repay a director loan. Indeed, the director can agree with their company when it should repay them.

The company can also pay you interest on the director’s loan to the company. When a company pays interest on a director’s loan account, the interest cost is a business expense. In addition, if you decide that the company will pay you interest on the loan from the director to the 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 is taxable income in a personal tax context for the contractor. If you’re the sole owner of your company, there’s no real benefit to paying any interest on a director loan to the company.

Ltd company loan to the director 

From a technical standpoint, under the Companies Act 2006, companies aren’t allowed to make loans to directors or shareholders. That is unless you obtain the shareholder’s approval first for a director’s loan from the company.

However, many UK contractors who run their own companies will always borrow money from their companies. Essentially, borrowing can arise where you take money from a company that isn’t either:

  • A salary, dividend, or expense repayment.
  • A repayment to the company of a previous loan to the director.

There is no limit on how much a director can borrow from the company. However, you must ensure you repay this in the future.

A loan to a director can be quite complex. If you prefer an accountant knowledgeable in such subjects, please read how to change your accountant.

Two tax effects for a loan to a director 

HM Revenue & Customs (HMRC) has two potential tax implications that connect with loans to directors. 

Tax effect 1 on contractor DLA -NI for company & tax for employee (P11D item) 

Loan to a director from the 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 when the loan amount from the company is more than £10,000. If the borrowing exceeds £10,000 at any time in a tax year, there’s a tax implication as a benefit in kind. As a result, you must report these on the PAYE year-end form P11D. Moreover, the employer must calculate your DLA’s `beneficial loan interest’. You must report the interest on the overdrawn loan account on form P11D. Furthermore, you must also report any benefits in kind on your Self-Assessment tax return each year.

HMRC beneficial loan interest rate

The beneficial loan interest is the interest on the overdrawn director loan account that the company owner or borrower hasn’t yet paid the employer. This interest is the taxable benefit in kind. You can use the DLA interest rate that HMRC publish. The current HMRC beneficial loan rate, or HMRC director’s loan interest rate in use, is 2.25%. Moreover, this DLA interest rate has been in place for 2023/24 and 2024/25, and you can find HMRC’s history of DLA interest rates here. In addition, you must report the loan interest benefit on your tax return.

Beneficial loan interest calculation & personal taxes

Let’s now consider how to do the beneficial loan interest calculation:

  • If your DLA 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 entire year) = £338.
  • If your DLA 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.

Depending on your overall personal income, you’ll pay personal tax on the interest benefit at 0%, 20%, 40%, or 45%.

Furthermore, the employer will pay Class 1A National Insurance (NI) on the interest. We’ll calculate this at 13.8% in 2024/25 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 temporarily advances funds to your spouse, HMRC will treat the borrowing as though it were to you. They’ve already considered this one.

What’s the tax-efficient way to deal with a loan to a company owner? 

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. The method here is a company can charge the director’s loan account interest to you. Indeed. you calculate interest on the overdrawn DLA for the period overdrawn during the tax year. As a contractor, when you pay their company the interest on the loan, there’s no benefit in kind. As a result, there’s no requirement to report the beneficial loan interest on the overdrawn DLA on form P11D.

How does the tax-efficient alternative way work?

As mentioned, 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 contractor. However, when they pay interest on their director’s overdrawn loan account to the company, it becomes extra business income. This additional 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 contractor paying their company interest on an overdrawn director’s loan account, the tax cost was the 19% Corporation Tax (CT) on the interest up to 31 March 2023. However, starting on 1 April 2023, your company pays CT at 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, 13.8% Class 1A NI is payable by the company. In addition, you have income tax 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 that the company director owes, it’s much more tax-efficient for your company to charge you interest.

Tax effect 2 on contractor DLA -Section 455 Tax 

Company advance to a 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 loan’s value.

Therefore, there’s a tax effect when:

  • The company will lend 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.

In summary:

  • If the DLA is overdrawn (the director will owe the company money) at the year-end, the company may have to pay tax.
  • However, the company won’t owe any tax if the entire amount is repaid within nine months and one day of the company’s year-end.
  • Any part of the loan 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 & how this works

If your DLA is overdrawn by 30 April 2024, you must repay this by 1 February 2025. If you repay the amount 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 an amount 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, a supplementary form for your company’s Corporation Tax return.

As stated above, the S455 Tax charge is now 33.75% of the appropriate loan amount. Out of interest, the rate of the S455 charge is the same as the higher rate tax on dividends. Presumably, the rate is set at this level to sway company directors from borrowing from their company for an extended time. Therefore, many contractors who do borrow from their company will attempt to repay this within nine months of their year-end.

It’s important to know that Section 455 Tax is refundable to your company in the future. HMRC will make an S455 repayment nine months after the financial year, during which you repay your DLA to your company.

If you don’t repay the DLA in time, the company will pay Section 455 Tax. Therefore, in between paying the tax and recovering this from HMRC, the company has tantamount lent the amount of tax to the Government.

How to repay the director’s loan?

When you’re ready to make a director’s loan repayment and repay part or all this, 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 will reduce or clear the DLA balance. 

Contractor director’s loan account & how to avoid Section 455 tax charge

A company can avoid the Section 455 charge on a limited company loan to the director if they repay the outstanding DLA balance before the corporation tax due date. This is due nine months and one day after your company’s year-end.

Director’s loans rules 

There are some anti-avoidance rules in place. Indeed, it’ll help if you don’t fall foul of these director’s loan rules. These rules will seek to ensure any DLA repayments are genuine repayments, as opposed to transactions designed to avoid the Section 455 Tax charge. Such transactions include taking out another loan very shortly after you’ve just repaid it.

Within the DLA rules, the main rule is a 30-day rule. This comes into play within 30 days when the borrower repays £5,000 or more. However, they then decide to borrow from the company again (this is known as ` bed and breakfasting’). This rule will render the DLA repayment ineffective, where they will borrow funds again within 30 days. It also doesn’t matter which comes first, the actual loan repayment or the further borrowing one takes; the 30-day period will apply equally. This measure will prevent a director from taking out further funds and using it to repay all or part of the original loan.

Contractor director’s loan account examples 

Let’s now look at some examples of company loans to directors. 

Example 1

John is a limited company contractor and owes his company £6,000 as of 30 November 2023. He initially took his contractor director’s loan during the year to 30 November 2022. John then makes a DLA repayment to repay the amount in full by 30 November 2024. Therefore, there’s 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 would 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 what she owes in full as of 30 September 2024. Therefore, Zoe’s company must now pay 33.75% (£1,350) of the £4K balance to HMRC.

If Zoe repays the balance of £4K to the company by 30 September 2026, the £1,350 will be refundable to her company on 30 June 2026.

Example 3   

Peter has a contractor limited company and 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 increased to £15,000 by 31 December 2023. Peter anticipates making a DLA repayment of £10K by 30 September 2024. Therefore, his DLA 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. This is because Peter repays the loan of £5,000 he took in the December 2023 year within nine months of the year-end.

The outstanding balance as of 30 September 2024 is £5,000. Therefore, a further £5,000 is repaid in connection with the December 2023 year. This £5,000 won’t receive S455 Tax relief, as the original £10,000 borrowing that Section 455 tax was paid on relates to the previous year. Instead, the company should 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 £5,000, the appropriate amount of S455 Tax is refundable by 30 September 2025.

Further variations of the above examples can also leave one mystified. If you have a great contractor accountant to guide you, they can ensure the tax on director’s loans is reported, paid, and recovered correctly.

Final thoughts 

When you run your own company, there can be a) a loan from the director to the 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. In this case, both tax consequences can apply.

Considering the guidelines above regarding a company loan to a director is vital. 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, 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 an 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

LinkedIn    https://www.linkedin.com/groups/4660081/

Published On: April 6th, 2024 / Categories: featured, Member Only Articles (Technical!), Other Guides, Running Your Own Company /

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