Introduction -what is a director’s loan account?
Are you a contractor, and a director of a limited company? If this is the case, there may come a time when you need to lend money to your company. This could arise because it needs to pay some future bills. Therefore when you lend to the company, this will be a loan from director to company. Alternatively, you may look to borrow money from your company if the need arises.
The reason for a director loan could emerge due to an array of reasons and, if a director borrows from their company, this is a loan to a director. Notably, if either of these scenarios arises, the amount you lend or borrow will be a contractor director’s loan. Therefore, how does a director’s loan work?
The total amount of the loan or advance between you and the company will be a director’s loan account. When you are a UK contractor, you can view this as your contractor director’s loan account.
When you are running a limited company the director loan account will show as a balance in your company’s Balance Sheet. In normal circumstances, the loan will be repaid in the future. However, a director’s loan could be an ongoing issue with a balance owing one way or another. We cover this later in the article.
Director loan agreement
In both cases, either a director loan from or to the company, is there a need for an official agreement in writing?
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. In the future, the business can repay you once it has the funds available and is in the position to do so. This loan from director to company will form part of your company’s Balance Sheet if you do not repay it by the company year-end.
There is also no time limit for when to repay the loan, and you can agree with your company when it should repay you.
The company can also pay you interest on director’s loan to company, and when it does this it is a business expense. If it is decided that the company will pay you interest it is up to the two parties to decide on the interest rate. However, the interest 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 benefit to this.
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.
However, many directors who run their own companies will always borrow money from their companies. Therefore, HM Revenue & Customs (HMRC) have two potential tax implications which connect with such loans.
Essentially, a company loan to a director can arise where you take money from the company that is not either:
- A salary, dividend or expense repayment.
- The repayment of a previous director’s loan to the company.
When it comes to how much can a director borrow from the company there is no actual limit. However, you must ensure that you repay this in the future.
A director loan is quite a complex area. If you prefer an accountant who has knowledge in subjects such as this, please read how to change your accountant.
Tax effect 1 -P11D item -National Insurance for the company and income tax for the employee
The first tax effect will relate to your personal tax. There is a loan to an employee and in this context, it is a director is an employee. This scenario will only apply where the amount you borrow is more than £10,000 at any time in a tax year.
Such a loan to the director is a benefit in kind, and you must report these on the PAYE year-end form P11D. The employer must work out the `beneficial loan interest’ on any director loan. You should also report this on form P11D. In addition, you must also report any benefits in kind on your Self-Assessment tax return each year.
The beneficial loan interest rate
The beneficial loan interest is the interest the borrower has not yet paid the employer. This interest is the taxable benefit in kind. You can use the interest rate that HM Revenue & Customs (HMRC) publish. The current director’s loan interest rate in use is 2.5% and you must also report the loan interest benefit on your Tax Return. Dependent upon your overall personal income, you will pay personal tax on the 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 15.05% on the same calculated interest and the Class 1A NI is payable just once per year. 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 is a more tax-efficient way to deal with a contractor director’s loan rather than declare this interest on form P11D. The method here is a company can charge interest to the director on the loan. When it does this, there is no need to report the loan interest on form P11D. As we mentioned earlier, the current HMRC interest rate is 2.5%, and this interest is a cost to the director. When the director pays interest to the company, it will become income for the company. As a result, this extra income will increase the bottom-line profit which is payable as dividends to the director.
Under this scenario, the tax cost is the 19% Corporation Tax (CT) on the interest. The CT is payable on the director loan interest income. When you compare this to the loan and P11D method, there is 15.05% Class 1A NI, which is payable by the company and income tax, which is payable by you as the director. You will pay this either at 0% or more likely 20% or 40%. Therefore, when there is a loan to a company director, it is much more tax-efficient for your company to charge the director interest.
Tax effect 2 -Section 455 Tax
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.
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.
- If the director’s 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 is subject to Section 455 Tax, which 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 rate was 25%.
Section 455 Tax and how this works
If your director’s loan account is overdrawn by 30 April 2022, you must repay this by 1 February 2023. If you repay the loan by this date, there will be no tax charge.
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 the option to take 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.
Please note that Section 455 Tax is refundable to your company. The tax will come back nine months after the financial year, during which you repay the 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.
Repay the loan
When you are ready to repay 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.
Avoid a Section 455 tax charge
A company can avoid the Section 455 charge if the director will repay the outstanding director’s loan balance before the corporation tax due date. This date is nine months and one day after your company’s year-end.
However, there are some anti-avoidance rules in place. Notably, it will help if you take care not to fall foul of these rules. These rules will seek to ensure that any repayments of the loan are genuine repayments, as opposed to transactions which are designed to avoid the Section 455 Tax charge. Such transactions will include when you take out another loan very shortly after you had just repaid it.
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 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.
Director’s loan account example
Let us now look at some contractor examples where there are company loans to directors.
John is a limited company contractor and owes his company £6,000 as of 30 June 2022. He originally decided to borrow all of this in the year to 30 June 2021. John will then repay this by 31 December 2022. Therefore, there is no S455 Tax payable.
Zoe will owe her company £6,000 as of 30 September 2022. Previously she said she will repay this within nine months of the 2022 year-end. At the next company year-end (30 September 2023), Zoe’s contractor director’s loan account will decrease to £4,000.
In this example, she does not repay the loan as of 30 September 2023. Therefore, Zoe’s company will now need 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 2024, the £1,350 will be refundable to her company on 30 June 2024.
Peter is a limited company contractor and will owe his company £10,000 as of 31 December 2022. His company has already paid over 33.75% of this (£3,375) as S455 Tax.
The director’s loan will increase to £15,000 by 31 December 2023. Peter anticipates this will decrease to £5,000 by 30 September 2024.
In this scenario, there is no S455 Tax due. Notably, the reason for this is because the £5,000 loan Peter takes in the December 2023 year is repaid 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 any director loans is reported, paid, and recovered correctly.
When you run your own company, there can be a) a loan from a director 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. 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.
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