Directors loan accounts - what happens when you owe the company money?
A directors’ loan account can be in credit or it can be in debit - i.e., the company may owe you money, or you may owe your company money.
Company directors taking loans out from their businesses is a very common way of being paid. A loan is issued and then, over the course of the following weeks and months, it will be paid back to the company with the issuance of salary, expense re-claims, and dividend payments. Problems arise when there are insufficient profits to pay dividends, and there have been no or small salary payments which are insufficient to account for the amount of money taken out of the company.
If you owe money to your company because it has lent you money, this is often referred to as an “overdrawn directors’ loan account”. What do you need to know about loans from companies to their Directors?
HMRC are interested
HMRC have long been worried about the “free flow” nature of directors’ loan accounts, especially since they may not appear on a tax return. If your directors’ loan account is overdrawn at the end of year, HMRC may to want to inspect why.
A directors’ loan account tends to be very fluid - money in as expenses are logged but not claimed or paid, money out as Directors take out money to cover their living expenses. Whitehill - in common with many bookkeeping and accounting practices - will be ok with this as long as we can reconcile and reorganise the account at the end of the year. But if we can see that there are insufficient profits - either in-year or brought forward - to cover a dividend being issued, then we'll flag it up and it may need to be treated as a loan from the company to you.
These things need to happen to allow a company to lend money to its director:
- the company is not in financial dire straits
- it’s in adherence with the company’s articles of association
- it complies with the 2006 Companies Act
- if under £10,000, shareholder approval is normally not needed
- if over £10,000, shareholder approval is given at a board meeting by ordinary resolution
- if the money is needed to meet company expenditure, it can be no more than £50,000.
What is the interest on a director’s loan?
It is up to your company what interest rate it charges on a director’s loan. However, if the interest charged is below the official rate (2% from April 2021) then the discount granted to the director may also be treated as a ‘benefit in kind’ by HMRC. This means that you as director may be taxed on the difference between the official rate and the rate you’re actually paying. Class 1 National Insurance (NI) contributions will also be payable at a rate of 13.8 per cent on the full value of the loan.
How much can I borrow in a director’s loan?
There is no legal limit to how much you can borrow from your company. However, you should consider very carefully how much the company can afford to lend you, and how long it can manage without this money. Otherwise the director’s loan may result in cash flow problems for your company.
Also bear in mind that any loan of £10,000 or more will automatically be treated as a ‘benefit in kind’ (see above) and must be reported on your self-assessment tax return. In addition you may have to pay tax on the loan at the official rate of interest. For loans of £10,000 or more you should seek the approval of all the shareholders.
How soon must I repay a director’s loan?
A director’s loan must be repaid within nine months and one day of the company’s year-end, or you will face a heavy tax penalty. Any unpaid balance at that time will be subject to a 32.5 per cent corporation tax charge (known as S455 tax). Fortunately, you can claim this tax back once the loan is fully repaid – however, this can be a lengthy process.
Claiming back corporation tax on an overdue director’s loan
If you have taken longer than nine months and one day to repay your director’s loan and have been charged corporation tax on the unpaid amount, you can claim this tax back nine months after the end of the accounting period in which you cleared the debt.
Can I repay a director’s loan and then take out another one?
You have to wait a minimum of 30 days between repaying one loan and taking out another. Some directors try to avoid the corporation tax penalties of late repayment by paying off one loan just before the nine-month deadline, only to take out a new one. HMRC calls this practice ‘bed and breakfasting’ and considers it to be tax avoidance. Note that even sticking to the ’30-day rule’ is not guaranteed to satisfy HMRC that you are not trying to avoid tax.
Taking out a director’s loan ‘by accident’
It is possible to take out a director’s loan inadvertently, by paying yourself an illegal dividend. As a director you may choose to take much of your income in dividends, as this is generally more tax efficient than a salary. However, dividends can only be paid out of profits, so if your business has not made a profit (or has no profits to bring forward) then legally no dividends can be paid.
If you don’t take enough care in preparing your accounts, then you may declare a profit by mistake and pay yourself a dividend. This illegal dividend should then be considered to be a director’s loan, and recorded in the DLA. You should then make sure to repay it within the nine-month deadline, or face tax charges.
How much tax are we talking about?
If a director takes out money from their business in the form of a loan, there will be no additional tax for the company to pay on it if it’s paid back nine months after the end of the company’s tax year. If you still owe money nine months after the end of the company’s tax year, there will be an additional corporation tax levied on your profit called S.455.
S.455 is charged at 32.5% of the outstanding loan or loans amount.
For example, you borrowed £30,000 from your company in June 2020. Your company end-of-year is 31st March 2021. That means that you have nine months after 31st March to pay back the £30,000 – that is, 31st December 2021.
But what if you couldn’t repay any of the £30,000? You’d have to enter 32.5% of that onto the S.455 section of your CT600 corporation tax return. So, your corporation tax bill would rise by £9,750.
If you paid your overdrawn directors’ loan account down by £10,000 leaving the balance at £20,000, your company would have to pay 32.5% of that £20,000 in S.455 corporation tax.
You can claim this extra corporation tax back once you've repaid the loan, with a difference process for this if the loan is outstanding for 2 year or more.
Benefit in kind
A benefit-in-kind payment is a method of payment to an employee (including a director) that does not take the form of cash. The most common types of benefits-in-kind are company cards, private medical insurance, and loans.
Let’s look at the rules around loans. When thinking about loans for benefit-in-kind purposes, a loan is the total amount of money borrowed over the course of a tax year. That could be one loan or ten loans.
If the total value of all loans taken out by a staff member total £10,000 or less over the course of a year, this is not considered a benefit-in-kind.
If it’s higher than £10,000, different rules apply and the loan must be declared on your tax return. The interest may also appear on a P11D "benefit in kind" form.
Can I write the loan off?
You can, but there are dangers. First, we’ll look at the mechanism.
If the money has been borrowed by a participator (i.e. any person having a share or interest in the capital or income of the company), then it can be written off and the amount written off is treated as a distribution (like a dividend payment).
If the person is not a participator, it will be treated as taxable income – i.e. it's subject to income tax and National Insurance Employees’ Contributions for them and National Insurance Employers’ Contributions for you.
For participators, it must be written off via a resolution passed at a board meeting.
There may be National Insurance consequences to a write off for the person, Class 1 National Insurance contributions are payable by your company, and, because it is distributed in the same way as a dividend, it’s not an expense so it won’t lower profits to bring down your Corporation Tax.
If you have paid the S.455 corporation tax on the overdrawn amount, you make a claim for the money back from HMRC for your company.
Insolvency and overdrawn directors’ loan accounts
If your company goes into liquidation soon after a loan has been written off, expect an insolvency practitioner to question the circumstances under which the write-off happened. The practitioner may view this as an action that is prejudiced against the company’s creditors.
If your loan remains unpaid and you’ve paid the S.455 corporation tax supplement, the insolvency practitioner will still consider the money as outstanding and will be within his or her rights to chase the money from you.