What is a director’s loan and how does it work?
It’s perfectly OK for directors of limited companies to borrow money from their businesses, but there are strict rules that need to be followed.
For sole traders, business and personal finances are more or less indistinct from one another. If you decide to take money out of your sole trader business, the tax implications are usually nil. If you’re registered as a limited company, however – typically making you both a director and shareholder — taking money out of company accounts is a bit more complicated.
It’s normal to receive money from your company in the form of salary or perhaps a dividend. Any other payment you take from company accounts is considered a director’s loan. Because the limited company is a separate legal entity, it has its own statutory obligations and accountability. That’s why records need to be kept for any money borrowed from it in a dedicated ‘director’s loan account’ (DLA). The balance of any money you owe to the company must be recorded in the DLA and included in the accounts you file with HMRC at the end of each financial year.
HMRC will use the information to calculate how much tax you owe on the loan. This could include:
- Personal tax on any director’s loan over £10,000. And if interest paid on the loan has been below the official rate, further tax may be due.
- Corporation tax if the loan is over £10,000 and not repaid within nine months of the end of the relevant tax accounting period.
- Class 1A National Insurance may also be due at a rate of 13.8% on the full amount.
For all of these reasons, director’s loans need to be handled with care. HMRC monitors DLAs closely when it reviews annual company tax returns, both to ensure all tax is being paid and that the rules and guidelines around director’s loans are being followed. Director’s loans are perfectly legal but potentially risky. You must follow the rules.
What information needs to be recorded in a director’s loan account?
Your DLA should include any cash withdrawals that you’ve made from company accounts as a director, and any personal expenses paid for with company funds or company credit card.
It’s vital to list any business expenses accurately in your limited company’s annual tax filing.
HMRC defines these as expenses incurred in (and relevant to) the performance of your duties as an employee of the limited company. HMRC will define anything outside this definition as a personal expense.
Your DLA needs to contain evidence of any transactions involving your personal finances – receipts, purchase orders, contracts, etc. – to ensure it’ll stand up to scrutiny by HMRC.
What kinds of purchases qualify for a director’s loan?
As a limited company director, you can take a loan from company accounts for pretty much anything you like, for example, paying for a new wardrobe or buying furniture for your home. The key is to record the loan accurately and keep the necessary evidence for any personal purchase on file.
Regardless of the reason for the purchase or payment, if the director’s loan hasn’t been subject to either personal or company tax, HMRC will expect you to pay whatever amount is due.
Avoid at all costs: recycling loans from one accounting year to the next
HMRC is clamping down on a method sometimes used to avoid tax on director’s loans called ‘bed & breakfasting’. It involves repaying any money borrowed from the company before year-end, temporarily closing it in the DLA to sidestep tax or penalties, then immediately taking out a new loan for an equivalent amount when the new accounting year begins.
Updated rules now dictate that when a director repays a loan of more than £10,000, a waiting period of 30 days needs to be followed before any further loan over this amount can be taken from company accounts.
Otherwise, HMRC takes the view that the director isn’t serious about paying the money back. The full amount is automatically taxed as a result.
Still have questions?
It’s always best to consult an accountant when dealing with things like director’s loans – particularly if you have written off, or plan to write off a director’s loan. Interest rates on director’s loans can also be difficult to understand.
To ensure you’re following the law and not liable for unexpected taxes or subject to a fine, contact us today. We’ll help you avoid nasty surprises and make sure you’re on the right side of HMRC’s rules.