Are Loans to Directors and Employees Tax-Free?

Are Loans to Directors and Employees Tax-Free
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In terms of HMRC, a director’s loan is when you take money from the company that may not be either:

  1. A salary, dividend, or expense reimbursement
  2. The money you have previously paid into the company

If a company makes loans to its directors, there may be tax consequences.

Why would you need to take a loan?

There are many reasons why you might need a loan from the company, such as covering an unexpected personal expense, a home repair bill, travel plans, etc.

It is important to remember that the money still belongs to the company, and it’s effectively a loan provided to you.

If a company provides loans to its employees (including directors), there are a couple of taxes to think about.

Tax paid by the company

This is called s455 and needs to be paid on the balance of the loan taken from the business by a director or employee, which remains outstanding nine months after the company yearend. However, when you repay the loan, you can reclaim the corporation tax, but not Interest.

Example:

A £30,000 loan is taken by M Manners, Director of ABC Ltd, during the company year ended 30 June 2020. M Manners paid back £5,000 on 30 September 2020, leaving £25,000 outstanding as of 31 March 2021 (9 months after the year-end). A s455 tax of £8,125 (£25,000*32.5%) is payable by ABC Ltd by 31 March 2021. This will be refunded back to the company by HMRC once the Director has repaid the loan amount.

Tax paid by the director

A company can provide an interest-free or low-interest loan to its employees or directors free of tax and National Insurance implications if the loan amount is below £10,000. If the loan is above this amount, it is subject to tax and national insurance on the employee as an advantage in kind and employers NI for the company.

To avoid this tax, interest can be charged on loan at the market rate.

Things you should know before taking a director’s loan:

  1. Money can be used for anything you like. The loan you take from the business can be used for any personal expense, and there are no limitations on what you can utilise it for.
  1. HMRC is watching you. HMRC keeps an eye on everyone who takes out a director’s loan as they can see this on your annual company return. Hence, you must keep records related to your directors’ loan account. Money withdrawals and repayments, personal expenses paid from the business account, and loan Interest could be examples of this situation.
  1. Repay the loan on time to avoid paying tax. Timing is key. The HMRC rule is that you need to pay back the loan within nine months after the company yearend to avoid paying tax on it.
  1. Tax rules. Whether you must pay tax or not on a director’s loan depends on when you repay the loan. If this is not repaid within nine months of the company’s yearend corporation tax, 32.5% needs to be paid. If the loan is above £10,000, it will be treated as a BIK, which must be declared in the form P11D. A further implication is that the company must pay class 1A National Insurance contributions at the rate of 13.8% of any benefit in kind provided, including the director’s loan.
  1. Loans are written off. If a loan provided to a director is written off, this will create a class 1 national insurance charge for the employee, which must report on a P11D. The company also must deduct and pay class National Insurance, from the employees’ salary, on the amount written off for tax purposes.
  1. Reclaim Corporation tax. HMRC will repay this only after nine months after the end of the corporation tax accounting period during which the loan was repaid/ written off. And must claim this within four years.

Do I need to record loans to directors and employees?

The answer is a big yes, you do need to record loans to directors and employees. It is essential to understand that the company is a separate legal entity with its statutory obligations and accountability. We must adequately document all transactions between the company and its directors and employees in the books and records.

If a firm has more than one director, each director must have separate directors’ loan accounts. You don’t have to pay any tax if your DLA remains in credit. However, if it has a debit balance, it means you owe the company money and needs to report to HMRC.

When it comes to employees, we would recommend having separate accounts related to any loans provided.

Bed and breakfasting

The measures initiated by the government to stop directors from managing their director’s loan accounts in a way that they can avoid tax is known as bed and breakfasting.

Directors tend to repay their loans before the yearend to avoid penalties, only to take it out again without any real purpose of paying back the loan.

Below rules have been imposed to counter this,

  1. When the Director repays a loan above £10,000, he should withdraw no further loans exceeding this amount within the next 30 days. In case this happens, the total amount will automatically get taxed.
  2. ‘Bed and breakfasting’ rules also apply if you make a repayment towards your Director’s loan of over £15,000 within 30 days and intend to take a new loan of above £5,000 in the future.

Given the complexity of the above rules, we recommend reaching out to an accountant about the most efficient way to repay your loan.

Tips:

  • A director’s loan can be a helpful way to get money out of a company for short-term purposes. This will avoid paying higher taxes on dividends or directors’ remuneration.

Keep the loan below £10,000 to avoid paying a benefit in kind tax and repay within nine months of the yearend to prevent paying additional corporation tax at 32.5%.

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