A Director’s Loan, and Who can take it?
A director’s loan is when the director withdraws money from the Company for his personal needs. This is not a salary, dividend, or expense repayment and therefore must be paid back to the Company.
Please note only the directors of the Company are eligible to claim this.
Director’s Loan Account & Two Types Available
All withdrawals and payments by the director are recorded in what we call a director’s loan account. This account helps us to identify the balances due or overpaid to the Company.
Further, this account also includes the following:
- Over withdrawal of salaries and expenses from the Company
- Personal fees paid for via the Company
- Interest on loans payable
We have two types of director’s loan accounts:
- When you owe the Company, the director is liable to pay back the loan to the Company. Therefore, the director becomes the debtor to the Company.
- When Company owes you – This is when the director lends money to the business to maintain activity. Therefore, the Company will be liable to pay the director back, which means the director becomes a creditor.
Is Director loan Interest & Tax-Free?
The answer can be “Yes” and “No”, but this will depend on certain factors and conditions.
The maximum amount a director can take from the Company, as interest-free is £10,000 during the Company’s accounting year-end, and this needs to be paid back within nine months and one day after the company year-end.
If the director withdraws more than £10,000 within the year, he has to pay the Company’s interest.
This will be explained later.
Tax Rules on Director Loans
- Corporation Tax: As mentioned before, the director’s loan must be paid back within nine months and one day after the accounting year-end. If it is not paid back within this time, they will be liable to pay a tax on the loan at 32.5% to HMRC. However, the director loan tax can be reclaimed back from HMRC (the interest amount cannot be reclaimed). Please see the explanation on this as you read.
- Self-Assessment Tax: If an interest-free director loan of more than £10,000 is taken, this will have to be used as a “Benefit in kind” and be recorded on a P11D form which must be then be submitted for tax on the director’s self-assessment return.
In addition, the Company will have to pay Class 1A National Insurance at 13.8% on loan.
Tax Implications and responsibilities
The tax implications and responsibilities depend on the following criteria:
- Loan Amount Taken
- The period is taken to settle the loan
- Method of paying the loan
There are two schemes to take into consideration:
- Director Loan paid back within nine months and one day after company year-end: If the director loan that was withdrawn is paid back within nine months after the year-end, the Company does not owe tax to HMRC. For example, if your company year-end is 31st March 2021, you must pay the director loan by 31st December 2021.
- Director loan not paid back within nine months and one day after the company year-end: Any loan not paid back within the nine months must pay a corporation tax of 32.5%, which amounts to HMRC. Interest will be added until this tax is paid.
For example: If a company’s corporation tax liability of £12500.00 is payable for the accounting year-end and a director’s loan of £15,000 is unpaid even after nine months and one day after the accounting period ended.
The total corporation tax payable by the firm will be as follows:
- Corporation Tax Liability – £12500.00
- Tax on Director Loan (32.5%) – £4,875.00
- Total payable – £17,375.00
Reclaim on Director Loan from HMRC
Please note the tax on the director loan can be reclaimed from HMRC once the loan is settled to the Company by the director in the future or if the Company writes off the loan. The timeline for the Company to reclaim this back is within four years.
Writing off a Director’s Loan?
If the Company writes off a director loan, this will usually be treated as dividends withdrawn and included in the self-assessment return. If the dividend amount is within the higher tax threshold, the tax payable will be 7.5%, but if it is above, the director will be liable to pay taxes at 32.5%.
Interest on Director Loans
If a director’s loan of more than £10,000 is withdrawn at any time within the year, the amount must be treated as a benefit in kind, and Class 1 National Insurance must be deducted from the Company.
In addition, the director is liable to pay interest on the amount due at the official rate. If the amount is paid back at an interest rate lower than the official, this difference will need to be treated as a benefit in kind.
Money Lent to the Company as a Loan by the Director
The Company treats this as a creditor as it owes back money to whoever lent money; therefore, no tax implications by the Company.
Can the director charge interest from the Company?
The director can charge interest from the Company. This will be treated as a business expense in its annual accounts and a personal income to the director.
Please note the personal income received must be reported in the director’s self-assessment return.
At the same time, the firm will have to pay the director an interest after deducting Income tax at 20% and report and pay this amount every quarter to HMRC using the form CT61 (Return of Income Tax on Company payments).
Bed and Breakfasting Rule
This is a government-induced rule to bring measures to stop directors from withdrawing loans to avoid taxation. Under this method, the directors repay the money they owe within the nine months and one-day period and start withdrawing loans immediately after this without the intention to pay it back.
For example, after a loan of more than £10,000 is repaid to the Company, no other loan above this amount can be withdrawn within a month.
If this rule is broken, HMRC assumes that the director does not intend to pay the money back to the Company and will charge tax on the total amount taken.
However, there are other instances where the director will be taxable under bed and breakfasting rules.
The rules will apply when the director wants to take out an additional loan without repaying any previous loans.