If you are a director and you are thinking about taking out a Director’s loan from your business, you need to know a few things before you do. Here are some of the most important things to consider.
What is a Director’s Loan?
A director’s loan is money borrowed or assets taken from a company by its director. Most companies with adequate bookkeeping system will have a directors loan account where any drawings or repayments are recorded.
Should you take out a director’s loan?
There are many advantages of taking a director’s loan, but it can also have some tax implications. A director’s loan is money that is lent to a director or close family member.
The main advantage of a director’s loan is that it provides a fast and easy way for a director to access company funds. However, it is important that you keep track of your director’s loans.
Directors can borrow from their companies in amounts that are unlimited. If the loan is more than £10,000, however, a shareholder or the board of directors must approve the loan.
The tax implications of taking out a director’s loan can vary depending on several factors, including the amount borrowed, the interest rate charged and the repayment date.
Is an overdrawn director’s account illegal?
Overdrawn director’s loans can cause problems for a company. This is because the money taken out of the company by a director can have tax implications if not repaid within a certain period.
However, an overdrawn director’s loan account is not illegal. The Companies Act 2006 removed the general rule that prevented companies from making loans to directors. However, a loan over £10,000 requires shareholders approval.
Why take a directors loan?
Director’s loans are an effective way of extracting money from a limited company. In particular, they can be useful for one-off expenses such as repair costs and emergency bills. However, they come with certain risks. So before you decide to take out a director’s loan, consider how much you can borrow, how long you will need to repay it and whether or not your business can run without the funds taken out as director’s loan.
Interest on a director’s loan
There is no rule that says interest has to be charged on a directors loan account. However, if there is no interest charged or the interest charged is below the official rate of interest, the difference would be taxed as a benefit in kind on the directors.
In addition to the benefit in kind tax, class 1 National Insurance will have to be paid on the benefit value of the loan. This is the difference between the interest charged on the loan and the official rate of interest.
Types of directors loans
There are two main types of directors’ loan accounts. Firstly, there is overdrawn directors Loan Account which relates to amounts taken out of a company by the company director. The other one is the amount put into a company by its directors.
If the amount of money put into the company by the director exceeds the amount drawn out of the company, the company will owe the director money. The director is at liberty to charge interest on the money owed to him or her by the company. However the interest will be treated as income in the hands of the director and taxed accordingly.
Tax on director’s loan
The tax implications of taking out a director’s loan can vary depending on several factors, including the amount borrowed, the interest rate charged and the repayment date.
Director’s loan have to be repaid within nine months of the end of a company’s financial year end. If a director’s loan is still outstanding after this period the company will need to pay HMRC additional corporation tax equal to 32.5% of the value of the loan outstanding. However, the corporation tax resulting from the loan will be repaid by HMRC when the loan is repaid by the director
In addition to the corporation tax, you will be liable to pay personal tax on the difference between the official rate of interest and the discounted rate of interest charged by the company.
Can a director’s loan be written off?
Yes it’s possible to write off the loan from your company. Bear in mind that if you do write off a director’s loan you will have to include the amount written off in your tax return as a dividend and pay income tax on it accordingly. The rate of income tax payable will depend on the director’s marginal rate of tax.
Many businesses choose to write off director’s loans. If a company writes off a loan to a director, it may also be liable for Class 1A National Insurance contributions. Furthermore the company will not get tax relief for the amount of loan written off.
How to repay an overdrawn director’s loan account
If you are a director in a company, you may have an overdrawn director’s loan account. Overdrawn director’s loan accounts can occur for a variety of reasons. There are a number of ways to clear the account.
Firstly, you can pay back the money owed to the company. You should try to do so within nine months of the end of the financial year. Otherwise, the company can be charged with a 32.5 percent corporation tax as mentioned previously.
Alternatively, you could consider declaring a dividend and using the dividend to settle the loan from the company. This is generally the most common route.
You could also pay a bonus to the director and use the bonus to clear the loan. Not many people go the bonus route because of the class 1 National Insurance that will be payable on a bonus.
What if the company goes into liquidation?
This can be a serious problem, especially if the company becomes insolvent. A liquidator will investigate the account and look to recover the debt. The liquidator will most certainly demand that the directors loans are repaid by the directors on a liquidation. The liquidator will take legal actions against directors in a bid to recover money owed by directors to a company in liquidation.
What else can count as loan to a director
Besides money drawn from a company by its directors, there are other transactions which can take the form of a director’s loan account and treated in a similar manner. For a close company, payments made to family members and friends of the directors are treated in the same way as a directors loan.