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The director’s loan is one area that causes a great deal of confusion for limited companies. What is it and why is it so important?

What is a director’s loan used for?

Let’s start with what it isn’t. The director’s loan is not a real bank account. You don’t need to go and set one up.

It’s a “virtual” account that only exists on your company balance sheet. The director’s loan account is a way of recording all the interactions between you as the director and the company.

The director’s loan is needed because the company is a separate legal entity from you, as the company director and / or shareholder. The company’s money is not your money. This is different from a sole trader where the business money and other assets belong directly to the business owner.

There are some common types of transaction that might be recorded in your director’s loan account.

Money-in director’s loan transactions

If you have salary being declared to HMRC via a payroll, but don’t actually pay yourself the money, it will show as money owed to you in the director’s loan.

If you pay for company expenses personally and don’t reimburse yourself, it will show as money owed to you in the director’s loan. This might be things like business use of home, mileage or cash travel expenses.

If you put your own money into the company bank account, for example if cashflow gets tight, then this shows as money owed to you in the director’s loan account.

When you’re a shareholder as well as a director, these transactions could also include dividends. If the company declares a dividend but you don’t actually pay yourself the money, it will show as owed to you in the director’s loan.

Money-out director’s loan transactions

If you take money from the company that’s not payroll salary, expense reimbursement or dividends, then it will go to the director’s loan account.

This would also include paying for non-business items through the company bank account, whether accidentally or intentionally.

Credit balance

Ideally your money-in transactions will always outweigh your money-out transactions. At any point in time, your director’s loan should have a nil balance or a credit balance. A credit balance means the company owes money to the director. You have made a loan to the company.

If you lend money to your company, you can charge interest on the loan balance. However there are some tax and administrative implications in doing this.

The interest counts as part of your taxable income for self assessment. It’s paid to you with 20% tax deducted by the company.

The interest can count as a business expense for the company. The company will also needs to report and pay the 20% tax deducted to HMRC every quarter.

What’s an overdrawn director’s loan?

When the money-out transactions outweigh the money-in transactions, the director’s loan has a debit balance. It is considered to be overdrawn. This means the director owes money to the company.

If you do end up with an overdrawn balance then you are left with three choices.

This blog article gives you some more information about these options.

If the relevant payroll filing period has past and you don’t have personal funds to repay the balance, then dividends may be the only option. But dividends aren’t always possible.

Dividends are declared from profits after tax, so the amount of dividends is limited by the available profit. If your company can’t afford enough dividends to fully clear the balance, your director’s loan account is left overdrawn.

An overdrawn balance on the director’s loan account can result in extra tax for the company and for you personally as the director.

Extra corporation tax

An overdrawn directors account (where the director is also a shareholder) is known as a close company loan to participators. A close company is one that is controlled by five or fewer participators (generally the shareholders) or one that is controlled by shareholders who are also directors.

If the company loans money to one of its participators, there is additional corporation tax to pay if the loan hasn’t been repaid within 9 months and 1 day of the company year end. The overdrawn loan balance (or any increase on the balance since last year) is currently taxed at 33.75%.

This also applies to loans made to associates of participators for example relatives such as your spouse, parents, siblings or children.

It’s not all bad news as it’s possible for you to get the extra corporation tax back. If you permanently repay the director’s loan during a future financial year, you can reclaim the extra tax.

However, the catch is that this can’t be done until 9 months and 1 day after the accounting period where the balance was cleared. So you get your extra tax back, but it’s not a quick process. Better to avoid having to pay it in the first place if you can.

Bed and Breakfasting

You may be wondering, can’t I just repay the loan before year end, then take the money out again the next day?

Unfortunately if you’re repaying more than £5,000 this falls under the rules for what is known as Bed and Breakfasting. You can’t put money in and then take it out again within 30 days.

For example, you owe £6,000 to the company and decide to pay it back just before the company year end to avoid extra tax. A week into the new financial year, you withdraw the £6,000 again, creating a new loan. However under the Bed and Breakfast rules, the £6,000 repayment you made before the year end is allocated to the new loan. This is because it’s within 30 days. The old loan remains, leaving the director’s loan still overdrawn at year end.

 These rules apply from 30 days before the year end to 9 months and 30 days after the year end date. So they cover the whole period you might need to repay an overdrawn director’s loan.

If your loan amount is more than £15,000, there are some additional rules that apply beyond the 30 days period.

Repaying your loan or withdrawing money through payroll salary or via dividends is fine. It’s not included as bed and breakfasting because both of these methods result in extra income tax. But you’re not allowed to put cash in and then take it back out again, without counting it as salary or dividends.

Writing off the loan

If I can’t bed and breakfast, can I just write off the overdrawn director’s loan as bad debt?

You can choose to write off a director’s loan but there are still tax consequences. The amount is treated as a deemed dividend for self-assessment and taxed accordingly. There would also be Class 1 national insurance to be paid by the company.

Benefits in Kind

Having an overdrawn director’s loan can also result in additional personal tax. An interest-free (or reduced rate interest) loan over £10,000 is known as a beneficial loan. It’s taxable as a benefit in kind.

If the company charges tax on the loan using at least HMRC’s official interest rate, then it’s not classed as a benefit. The interest is counted as additional taxable income for the company.

Otherwise the average loan balance (end balance plus start balance, divided by 2) is used. The value of the benefit is the interest that would have been due on the average balance, using HMRC’s interest rates. If interest was partially paid or paid at a lower rate, then the benefit would be the difference between the two amounts.

Unfortunately there’s no way to reclaim any tax on benefits in kind once the loan is repaid.   

Avoiding extra tax

The best way to avoid extra tax is to make sure that the director’s loan doesn’t get overdrawn.

This blog article goes into more details about how you can take money out of your limited company without ending up with director’s loan issues.

The most important thing is to plan up front about what you need and how you will take that money. You can only take what the company can afford. Nothing creates director’s loan issues faster than lots of random, unchecked cash withdrawals that add up much more quickly than you realise.

Speaking to your accountant and planning together is a great way to make sure that you are making the most tax efficient decisions for both you and your limited company.

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