This article tells you about the various tax issues arising from a director's loan, the records you need to maintain, requirements under company law, and possible methods for paying back such loans.
Using a directors loan account
If you are a director or shareholder of a company, you may take money to:
- pay a third party to whom the company owes that money
- pay your salary, bonus or other money due to you as an employee
- draw down or repay to yourself money that you have lent to the company at some past time
- pay a dividend that has been properly authorised by the company
Any other money paid to you or on your behalf is technically a director loan by the company to you.
Clear record keeping
The first thing to note is that all money credited to or debited from a company by a director should be recorded in the appropriate director's loan account at the time of the transaction.
A director's loan account should clearly distinguish between business and personal spending, and between earnings and loans.
A director may pay business expenses on behalf of the company, which would be recorded as a credit in the director's loan account, and the company could claim tax back on such a business expense.
A director's salary could be used to offset an overdrawn director's loan account - again a credit, but income tax and National Insurance Contributions need to be paid on this amount, since these are earnings.
In the case where a director uses their account for personal expenses, this is a debit on the account. If it causes the account to be overdrawn it is a loan, and the tax issues are covered below.
It is crucial for tax calculations that loan accounts accurately record all transactions and the dates when they occur. There should be separate accounts for each individual.
In some cases it may be logical to create more than one account per individual, for example if they are charging interest on one loan but not another. Each of these accounts must be considered separately for tax calculations.
It's likely that you won't pay any interest on money drawn on a director's account, and therefore you effectively save money when compared with alternative means of borrowing.
If at any point during the tax year your account is overdrawn by more than £10,000, HMRC requires that you declare and pay income tax on this notional income, known as a 'benefit in kind'. Furthermore, because this is interpreted as employment income, the company will have to pay national insurance tax on this amount.
If you do not repay the loan within 9 months of the end of the company's corporation tax period the company will have to pay 25% of the outstanding amount in corporation tax. This can be reclaimed by the company once you have repaid the loan, but it can take from 9 to 21 months to recover this tax (but you could obtain repayment by deduction from the sum due in the year following).
If you repay the loan within the 9 month deadline, then the company will not have to pay corporation tax on the loan, but must report it on the company tax return. However if you repay the loan before the end of the company's corporation tax period the loan does not need to be declared.
Bed and breakfasting is the practice of repaying the loan amount before the end of the corporation tax period (or the 9 month deadline), and then withdrawing the same amount shortly afterwards.
If the purpose of the transaction is to reduce corporation tax or to give an on-going benefit to a director it constitutes tax evasion. If HMRC become aware of the situation, penalties may be applied.
If the loan is for more than £10,000, it must be formally approved by a resolution of the shareholders of the company and disclosed in the company accounts.
Smaller loans are exempt from this requirement.
It is common for directors' loans to be repaid by company participants voting a bonus or dividend to clear the overdrawn balance. If a bonus is used, then income tax and national insurance tax will be due.
It goes without saying that payment of any dividend should be properly voted and the resolutions documented in accordance with the Companies Act 2006.
Watch out for bad timing too. A final dividend voted at an annual general meeting with no specified payment date creates an immediate debt to the beneficiary of the dividend. However interim dividends voted between annual general meetings are only considered paid when the actual transaction takes place.
In some situations it may be sensible to release the loan, for example in owner-operated businesses. This has the advantage that the company does not need to pay corporation tax.
However the individual released from the loan will need to pay income tax on the loan amount.
If the individual is a 'participator' in the business (i.e. they have a share or interest in the business), the amount is taxed at the usual rate for dividends.
If the individual is not a participator but an employee, then the amount will attract a general employment income charge and national insurance tax.
If the individual is both a participator and an employee, then it must be made clear in which capacity - participator or employee.
Recording that a loan has taken place is important. A written loan agreement should be used as evidence of the terms. It might be of interest to shareholders, other directors or HMRC. Net Lawman offers a number of loan agreement templates for different types of loans.