Last time on the Countplus blog we covered the basics of a Director’s Loan Account. To make an informed decision about director’s loans, it’s important to have a deeper understanding of the concept. This includes the workings of your director’s loan account and the responsibilities and risks associated with borrowing or lending money in this manner.
That’s what we’re going to go into in this article. So if you understand the basics, we’re going to go a little further and help you to make good, informed decisions regarding your DLA by answering some common questions.
Why Might I Need a Director’s Loan Account?
If you’re a company director, you may sometimes find yourself in need of additional funds beyond what you receive in the form of salary or dividends. In such situations, taking out a director’s loan from your company could be an option worth considering. This loan facility can provide you with access to more money than your current income allows.
Typically, director’s loans are utilised to cover short-term or one-off expenses, such as unexpected bills or personal financial emergencies. However, it’s essential to keep in mind that borrowing in this manner comes with administrative requirements and risks, such as the potential for heavy tax penalties if the loan is not repaid according to the appropriate regulations.
It’s important to note that director’s loans should not be used routinely, but rather kept in reserve as an emergency source of personal funds.
Therefore, before deciding to borrow from your company, it’s crucial to carefully consider the necessity of the loan and the implications of the borrowing decision. Seeking professional advice and guidance from your accountant can also be beneficial to make informed decisions.
Is There a Standard Interest Rate on Director’s Loans?
Your company has the discretion to set the interest rate on a director’s loan. However, if the interest charged on the loan is lower than the official rate, it can trigger an additional tax liability for you as a director. This is because HM Revenue and Customs (HMRC) may treat the difference between the official rate and the rate charged to you as a ‘benefit in kind’, which is subject to taxation.
Furthermore, if you take out a director’s loan, you’ll be liable to pay Class 1 National Insurance contributions at a rate of 14.53% on the full value of the loan. Therefore, it’s crucial to carefully consider the interest rate on the loan and the potential tax implications before making any borrowing decisions.
The official rate of interest changes periodically, in response to changes in the base rate. As of the tax year 2022/23, the official rate of interest for director’s loans stands at 2%.
It’s worth noting that the official rate can have implications for the tax treatment of any interest-free loans provided by your company, so it’s essential to stay updated with any changes to the official rate to ensure compliance with relevant regulations.
Is There a Limit To How Much I Can Borrow?
Although there is no legal limit to the amount you can borrow from your company, it’s crucial to consider how much the company can afford to lend you and the potential impact on the company’s cash flow. Careful consideration is essential to avoid any unintended consequences resulting from the director’s loan.
It’s also essential to keep in mind that you have to treat any loan of £10,000 or more as a ‘benefit in kind’, as mentioned earlier. This means that you must report the loan on your self-assessment tax return, and you may be liable to pay tax on the loan at the official rate of interest. For loans of £10,000 or more, we recommend you seek the approval of all shareholders.
Therefore, before borrowing from your company, it’s vital to evaluate the potential risks and consequences associated with the loan. It’s important to strike a balance between fulfilling your personal financial needs and safeguarding the financial stability of your company. Speak to us if you’d like some further guidance. Or if you are unsatisfied with your accountant’s help in this area, consider switching to Countplus.
How Soon Do I Need To Pay My Director’s Loan Back?
To avoid incurring heavy tax penalties, you must repay a director’s loan within nine months and one day of your company’s year-end. If any balance remains unpaid at this time, it will be subject to a 32.5% corporation tax charge, known as S455 tax.
Fortunately, you can claim this tax back once the loan is fully repaid. However, the process of reclaiming the corporation tax can be lengthy and burdensome. Therefore, it’s best to ensure that you don’t end up in this position by repaying the loan within the stipulated time frame.
Reclaiming Corporation Tax for an overdue Director’s Loan
If you’ve taken longer than nine months and one day to repay your director’s loan and have been charged corporation tax on the outstanding amount, you can claim this tax back nine months after the end of the accounting period in which you cleared the debt. However, this can be a long time to wait, and the process can be onerous.
One possible workaround is to delay paying your company’s corporation tax until you’ve fully repaid the director’s loan. This can give you extra time to repay the loan, as the corporation tax payment deadline is nine months after your financial year-end.
Nevertheless, it’s important to exercise caution and consider the potential impact on your company’s financial stability before opting for this strategy.
How Long Do I Have To Wait Before I Can Take Out Another Director’s Loan?
If you’re planning to repay a director’s loan and then take out another one, it’s essential to keep in mind that you must wait for a minimum of 30 days between repayment and the new borrowing.
Some directors attempt to avoid the corporation tax penalties for late repayment by paying off one loan just before the nine-month deadline and taking out a new one. This practice is known as ‘bed and breakfasting,’ and HM Revenue and Customs (HMRC) considers it to be tax avoidance. Even if you follow the 30-day rule, it’s not guaranteed to satisfy HMRC that you’re not attempting to avoid tax.
Therefore, it’s crucial not to rely on director’s loans for additional cash and avoid making a habit of borrowing and repaying to circumvent tax regulations. The responsible use of director’s loans is important to avoid any legal and financial issues that may arise due to non-compliance with relevant regulations.
What Is An Accidental Director’s Loan?
It’s possible to unintentionally take out a director’s loan by paying yourself an illegal dividend. As a director, you may opt to receive a significant portion of your income in the form of dividends since it’s generally more tax-efficient than a salary.
However, dividends can only be paid out of profits, so if your business has not generated a profit, legally, no dividends can be paid. If you’re not careful enough while preparing your management accounts, you may accidentally declare a profit and pay yourself a dividend, which is illegal.
In such cases, the illegal dividend should be considered a director’s loan and recorded in the Director’s Loan Account (DLA). You must ensure to repay the amount within the stipulated nine-month deadline to avoid any penalties or legal issues.
For this reason, it’s crucial to exercise due diligence in preparing your management accounts and seeking professional advice if you’re unsure about any aspect of the dividend payment process. Keeping accurate records of all financial transactions can help you avoid any inadvertent breaches of regulations related to director’s loans and dividends.
Is It Possible To Lend Money To Your Company?
It’s possible to lend money to your company if you want to invest money into the company temporarily. This could be an option to fund ongoing activities and/or purchase assets.Lending money to your company is also called a director’s loan.
If you decide to charge interest on the loan, any interest paid to you by the company is considered income and must be recorded on your self-assessment tax return. The company treats the interest paid to you as a business expense and must deduct income tax at source at the basic rate of 20%. However, the company will not pay corporation tax on the loan.
Before lending money to your company, it’s important to carefully evaluate the financial needs and stability of the company to determine the appropriate loan amount and repayment terms. Seeking professional advice from an accountant or financial advisor can also be beneficial to make informed decisions and avoid any inadvertent breaches of regulations related to director’s loans. Keeping accurate records of the loan transaction can also help to avoid any legal or financial issues that may arise in the future.
A Helpful Checklist When Considering a Director’s Loan
If you’re considering borrowing money from your company or lending money to it, there are some important factors to keep in mind. Please refer to the following checklist:
- Borrow from the company only when necessary, after exploring other options.
- Repay the director’s loan within nine months and one day of the company year-end, if possible.
- Consider borrowing less than £10,000.
- For loans of £10,000 or more, report it on your self-assessment tax return, and the company must treat it as a benefit in kind.
- Wait for at least 30 days before taking out another director’s loan.
- If you lend money to your company, ensure both you and the company use the correct tax treatment.
- Avoid over-drawing your Director’s Loan Account (DLA) for prolonged periods.
- Ensure that your company has generated a profit before declaring dividends.
As director’s loans are a complex area, it’s important to be vigilant and seek professional advice if necessary to ensure that you follow the relevant regulations and avoid legal or financial issues.