Introduction -what is a director’s loan?
When you are a director of a limited company, there may be a need, at one time or another, for you to lend money to the company.
Alternatively, you may need to borrow money from your company if the need arises.
One way or the other, the total amount of the loan or advance between you and the company will become a director loan account.
In both cases, where you are the sole director of your company, there is no need for a written director loan agreement. However, if you are part of a company with more than one director, an agreement may need to be put in place, as other parties are involved.
Director loan to company
When you lend money to the company, it can pay you back in the future. You can do this once the business has the funds and is in the position to do so. This loan from the director to the company will form part of your company’s Balance Sheet if it is not repaid by the year-end.
There is also no time limit for repayment, and you can agree with your company when it should repay you.
The company can also pay you interest on the loan, which will be a business expense if it does. However, this interest would become taxable income in a personal tax context for the director. If you are the sole director of your company, there is no benefit in doing this.
Company loan to director
From a technical standpoint, it is not allowed under the Companies Act 2006 for companies to make a loan to a director or shareholder. That is unless the shareholder’s approval is obtained first.
However, many directors who run their own companies always borrow money from their companies. Therefore, HM Revenue & Customs (HMRC) has two potential tax implications that 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.
A director loan can be quite a complex area. If you would like an accountant that is knowledgeable in subjects such as this, please have a read of 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 relates to your personal tax.
There is a loan to an employee. In this context, a director is an employee:
This scenario will only apply where the amount you borrow exceeds £10,000 at any time during a tax year.
Such a loan to the director is a benefit in kind, and you need to report these on the PAYE year-end form P11D. The employer must work out the `beneficial loan interest’ on any director loan. This will then need reporting on form P11D. Any benefits in kind also need reporting on your Self-Assessment tax return each year.
The beneficial loan interest is the interest the borrower has not 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 rate of interest that is in use is 2.5%. You will also need to report the loan interest benefit on your Tax Return. Depending on your other personal income, you will pay personal tax on the benefit at either 0%, 20% or 40% or 45%.
Furthermore, the employer needs to pay Class 1A National Insurance (NI). This is calculated at a rate of 15.05% on the same calculated interest. 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 director loan than declaring interest on form P11D. The method here is a company can charge interest to the director on the loan. When it does, there is no requirement to report the loan interest on form P11D. As mentioned, the current HMRC interest rate is 2.5%, and this interest will be a cost to the director. When the director pays interest to their company, it will become income for the company. As a result, this extra income will increase the bottom-line profit, payable as dividends to the director.
Under this scenario, the tax cost is the 19% Corporation Tax (CT) on the interest. The CT will be 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 0% but 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:
There is a tax effect when:
- The company makes a loan to a shareholder (who in this case is also a director) during 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 owes 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 won’t owe any tax.
- Any part of the director’s loan that is not repaid will be 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 was overdrawn by 30 April 2022, it must be repaid by 1 February 2023. If it is repaid 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 that is not repaid by the end of the current year. Where there is a loan due at the end of your last financial year that has not been fully reimbursed by the end of the current year and Section 455 tax has not been paid on this previously, there would be 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 the same as the higher rate tax on dividends. The rate is presumably set at this level to sway company directors from considering the option to take a loan for a longer time. 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 the loan is repaid to the company.
When a loan is not repaid in time, and the company pays Section 455 Tax, in between the tax being paid and subsequently recovered from HMRC, the company has tantamount loaned the amount of tax to the Government.
Repaying the loan
When you come round to repaying the loan, you can either:
- Repay 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 reduces or clears the loan balance.
Avoiding a Section 455 tax charge
The Section 455 charge will be avoided if the outstanding director’s loan balance is repaid or cleared 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 would help if you took care not to fall foul of these rules. These seek to ensure that any repayments of the loan are genuine repayments, as opposed to transactions designed to avoid the Section 455 Tax charge. Such transactions would include taking 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 repayment of more than £5,000 is made. However, the director then borrows from the company again (this is known as ` bed and breakfasting’). This rule will render the repayment ineffective, where funds are borrowed 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 prevents a director from taking out a new loan and using it to repay all or part of the original loan.
Director loan examples
John owes £6,000 to his company as of 30 June 2022. He decided to borrow all of this during the year to 30 June 2021. John then repays this by 31 December 2022. Therefore, there is no S455 Tax payable.
Zoe owes £6,000 to her company as of 30 September 2022. Previously she said she would repay this within nine months of the 2022 year-end. At the next company year-end (30 September 2023), Zoe’s director’s loan account decreased to £4,000.
Therefore, the loan is not paid back as of 30 September 2023. Zoe’s company will now need to pay 33.75% (£1,350) of the £4K over to HMRC.
If Zoe’s company repays the £4K by 30 September 2024, the £1,350 will be refundable to her company on 30 June 2024.
Peter owes £10,000 to his company as of 31 December 2022. His company has already paid over 33.75% of this (£3,375) as S455 Tax.
The director’s loan increases to £15,000 by 31 December 2023. Peter anticipates this will decrease to £5,000 by 30 September 2024.
In this scenario, there will be no S455 Tax due. There is no tax due because the £5,000 loan Peter takes during the December 2023 year will be paid back within nine months of the year-end.
The outstanding loan balance as of 30 September 2024 will be £5,000. Therefore, a further £5,000 of the loan is paid back 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 will need 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 get quite confusing. 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 could 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 could apply.
It is key to take into account the guidelines above. If you borrow from your company, please aim to repay it within nine months of the company year-end. When you have an extended director loan, please consider paying your company interest, as this is much more tax-efficient than 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