What is a Director’s Loan and How Does it Work in the UK?

by | Dec 11, 2019

What is a Director’s Loan and How Does it Work in the UK?

If you are running a limited company in the UK, you might have heard of a director’s loan. However, not everyone is familiar with this legislation. A director’s loan can empower company owners and is an additional perk that comes with owning a business. A director’s loan can be used for any reason, there isn’t a spending criteria you must meet. However, you must take into consideration that a director’s loan is not your money but the company’s money. Therefore, it is a loan of money that is not technically yours so HMRC will expect you to pay it back!

Before you take a director’s loan these are the things to be aware of: 

What is a director’s loan? 

What is a directors loan

A director’s loan refers to any money taken out by a director from the company, where it’s not paid out as a salary, dividend, or expense. 

A salary paid to a director is considered the same as a salary paid to an employee. It involves registration to HMRC and PAYE. Meanwhile, a dividend is a payment made by a company to its shareholders based on the number of shares they own and the company’s profits. A director’s loan, however, must be paid back to the company. 

 

What is a director’s loan account?

A director’s loan account is a record of transactions between a company and its directors (excluding salary and dividends). It is vital to keep a record of any money borrowed or lent out by your company. This recording is called the director’s loan account or DLA. 

At the end of the financial year, all money owed to the company must be included on the balance sheet. 

 

<h3id=”who-can-take-a-directors-loan”>Who can take a director’s loan?

In order for you to take advantage of a director’s loan you must be a director of the company.

How does the director’s loan work?

There are many reasons why a director might take a director’s loan from their company. You can spend a director’s loan on anything you want – a new house, a new car or a new investment! 

Before you take the money from your business account you must get approval from all the company shareholders. A record of your shareholders’ approval should be kept in writing.  This is very easy to process if you are the sole director and shareholder of your company. 

Remember to keep money in your business bank account to cover your liabilities! HMRC will not accept late payment because of a large director’s loan payment. 

Is a director’s loan taxable?

You may have to pay tax on a director’s loan. Your company may also have to pay tax if you’re a shareholder (sometimes called a ‘participator’) as well as a director.

Your personal and company tax responsibilities depend on whether the director’s loan account is:

  • Overdrawn – you owe the company
  • In credit – the company owes you

 

When do you repay your loan?

Typically you would repay the loan within 9 months of the end of your Corporation Tax accounting period.

 

How is the director’s loan settled?

If you owe the company, you or your company may have to pay tax if you take a director’s loan.

How the loan is settled
Your company’s responsibilities if you’re a shareholder and director
Your personal responsibilities when you get a director’s loan
You repay the loan within 9 months of the end of your Corporation Tax accounting period

Use form CT600A when you prepare your Company Tax Return to show the amount owed at the end of the accounting period.

If the loan was more than £5,000 (and you took another loan of £5,000 or more up to 30 days before or after you repaid it) pay Corporation Tax at 32.5% of the original loan, or 25% if the loan was made before 6 April 2016. After you permanently repay the original loan, you can reclaim the Corporation Tax – but not interest.

If the loan was more than £15,000 (and you arranged another loan when you repaid it) pay Corporation Tax at 32.5% of the original loan, or 25% if the loan was made before 6 April 2016. After you permanently repay the original loan, you can reclaim the Corporation Tax – but not interest.

No responsibilities
You do not repay the loan within 9 months of the end of your Corporation Tax accounting period

Use form CT600A when you prepare your Company Tax Return to show the amount owed at the end of the accounting period.

Pay Corporation Tax at 32.5% of the outstanding amount, or 25% if the loan was made before 6 April 2016.

Interest on this Corporation Tax will be added until the Corporation Tax is paid or the loan is repaid.

You can reclaim the Corporation Tax – but not interest.

No responsibilities
The loan is ‘written off’ or ‘released’ (not repaid)
Deduct Class 1 National Insurance through the company’s payroll.
Pay Income Tax on the loan through a Self Assessment tax return

 

When is a loan classed as a benefit in kind?

The loan will be treated by the company as a ‘benefit in kind’ if you’re a shareholder and director and you owe your company more than £10,000 (£5,000 in 2013 to 2014) at any time in the year. The company must also deduct Class 1 National Insurance whilst you must report the loan on your personal Self Assessment tax return. You may have to pay tax on the loan at the official rate of interest.

 

What is ‘bed and breakfasting’?

Bed & Breakfasting is a term introduced by the government to stop directors from managing their own director’s loan account in a way that allows the business data to be manipulated to avoid tax.

In some cases, directors have repaid their borrowed money to the company before the year end to avoid penalties to dodge tax, only to immediately take it out again without any real intention of paying the loan back.

Taking a director’s loan from the company should only be done when all tax and accounting implications have been considered. Ensure you talk with your accountant to get a recommendation for your personal circumstances. Book a FREE TAX Review to understand the best options for your business. 

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