What is the purpose of a director's loan and how do they work?
Over the past couple of months we've come across a few clients that wanted to know more about Director's Loans and how to make them work for your business.
Here's a helpful overview for you from Zyla Accountants.
Would it be a good idea to take out a director's loan from my company? Do I need to lend money to my company?
As a director, you may encounter either of these questions from time to time.
You'll need to understand what a director's loan is, how your director's loan account works, as well as the responsibilities and risks associated with borrowing and lending money.
How does a director's loan work?
Director's loans are money taken from your company's account that cannot be classified as salaries, dividends, or legitimate expenses.
Essentially, you will have to repay the money you borrowed from your company as a director.
Director's loans can also be given out when a director lends money to the company to assist with start-up costs or to help it through cash flow problems. This results in the director becoming a creditor of the company.
Why might my company lend me money?
Director's loans can provide you with access to more money than you are currently receiving from salary or dividends.
In most cases, directors' loans are used to cover short-term or one-time expenses, such as unexpected expenses.
It is important to only use them as an emergency fund, especially since they are admin-heavy and can result in punitive tax penalties.
How does the director's loan account work?
DLAs are where directors record all the money they borrow or lend to their companies.
The account is in credit if the company borrows more money than it lends.
If the director(s) borrow more, the DLA is said to be overdrawn.
In the event that your DLA is overdrawn for any period, shareholders (and possibly other creditors) may become concerned.
At the very least, you should aim to keep it in credit most of the time.
Put together a director's loan account with the help of an accountant for your small business.
How much is the interest on a director's loan?
Your company decides what interest rate it will charge on director's loans.
If the interest rate is below the official rate, then the director's discount may also be considered a 'benefit in kind' by HMRC.
Directors may be taxed on the difference between their official rate and their actual rate.
Additionally, 13.8 percent National Insurance (NI) will be due on the interest not paid.
Changing base rates affect the official rate of interest over time.
What is the maximum amount I can borrow from a director's loan?
The amount you can borrow from your company is not limited by law.
It is important to evaluate the company's ability to lend you money, and how long it can survive without it.
A director's loan may cause your company to have cash flow problems.
You have to report any loan of more than £10,000 on your self-assessment tax return and it must be treated as a 'benefit in kind', but your benefit amount could be £0 if you have already been charged interest at the HMRC approved rate.
The official interest rate on the loan may also be taxed. The shareholders should approve loans of £10,000 or more.
What is the deadline for repaying a director's loan?
You will be subject to a heavy tax penalty if you do not repay your director's loan within nine months and one day of the end of the company's fiscal year.
A 32.5 per cent corporation tax (known as S455 tax) will apply to any unpaid balance at that time.
The good news is that you can claim this tax back once the loan has been fully repaid - although this can take a long time.
Overdue director's loan: claiming back corporation tax
Corporation tax can be reclaimed nine months after the end of the accounting period in which you repaid your director's loan if you took longer than nine months and one day to repay it.
If you don't want to end up in this position, make sure you don't wait this long.
If you are unable to repay your director's loan, you can postpone paying your company's corporation tax.
You have nine months to pay your corporation tax after the end of your financial year, so you can repay the loan more quickly.
Is it possible to take out another director's loan after repaying one?
Taking out a loan and repaying it must be done within 30 days of each other.
Paying off one loan just before the nine-month deadline, then taking out another, is one way directors try to avoid the corporation tax penalties of late repayment.
HMRC considers this practice as tax avoidance by calling it 'bed and breakfasting'. You should be aware that even following the '30-day rule' does not guarantee that HMRC will not suspect you're trying to avoid taxes.
For this reason, you shouldn't rely on director's loans as a source of extra income.
Making a director's loan 'by accident'
Paying yourself an illegal dividend can even result in you taking out an inadvertent director's loan.
You may prefer to take much of your income in dividends rather than a salary as a director.
As a result, if your business has not made a profit, then dividends cannot be paid.
In the event that you don't prepare your management accounts carefully, you may declare profits by mistake and pay yourself dividends.
It should be recorded in the DLA as a director's loan. Make sure that you repay the loan within nine months.
Does my company qualify for a loan?
Your company can also receive a director's loan if you lend to it.
You may want to consider this if you want to invest money into your company (for instance, to fund its ongoing activities or acquire assets) but only on a temporary basis.
Interest you receive from the company must be reported on your self-assessment tax return if you decide to charge interest.
The company must deduct income tax at source from the interest you receive as a business expense. However the company will pay no corporation tax on the loan.
The director's loan checklist
If you want to borrow or lend money to your company, here is a short summary of what you should remember.
Use director's loans only if absolutely necessary (i.e. consider all other options before taking them out).
If possible, repay your director's loan within nine months after the company's year-end
Keep your borrowing under £10,000.
You have to report any loan over £10k and it must be treated as a 'Benefit In Kind'.
Make sure you wait at least 30 days between director's loans
To ensure the correct tax treatment for you and your company, ensure that you both use the correct tax treatment
Allow your DLA to remain overdrawn for no more than a few days
Before declaring dividends, make sure your company has made a profit
In summary, director's loans are tricky, so should not be used lightly or routinely.
Please let Zyla Accountants know if you have any questions on this subject, we'll be happy to help with your plans.