A directors loan account can be said to be an extensive record of transactions between a company and its directors. This record is a record that is considered to be apart from a persons salary and dividends. This article is going to be talking about all the things that go into the director loan accounts. It will also be addressing why people opt for a directors loan account instead of other legitimate ways to withdraw money from the business.
The Basics of a Director Loan Account
In simple terms, a director loan account within a company exists when either; a director borrows money from the company. The director is known as a debtor of the company OR a director lends money to the company and are known as a creditor.
In the first case, this is know as an overdrawn director loan account, and is similar to a bank overdraft. In this situation, the loan does not necessarily need to be repaid back to the company, but there are tax consequences of not doing so within a certain time period.
Who and Why a Director Loan?
As the name suggests, a director loan can be taken or provided by a director. Borrowing money from your company is essentially done for cash flow purposes. Although there can be tax benefits too, if timed correctly. Ordinarily there are 3 key ways of extracting money (legitimately) from your company as follows:
1) Director Salary
3) Director Loan
The first two are a common way of extracting personal (director) remuneration from your company. Often an optimal director salary is paid out to you the director, with dividends on top. The tax treatment of a director salary and dividends differ.
A director loan is an excellent way of accelerating personal cash flow from your company. If you have reached the limits or thresholds of a director salary and dividend remuneration, then a loan from your company can help you with short term cash flow.
What Paperwork is needed for a Director Loan?
It’s quite simple for a small business to obtain shareholder approval for a director loan (the director borrows money from the company) as the director(s) and shareholder(s) are often one of the same.
It is strongly advisable that for any loans above £10,000, shareholder approval is formally documented and a formal loan agreement is created between the company and director.
Shareholders grant their approval by way of a special resolution.
How much can you borrow as a Director Loan?
If you as a director are borrowing money from your company, then technically there is no imposed limit as to how much you can borrow. The key here is to ensure your company has sufficient cash reserves to lend you the amount you want to borrow without compromising it’s obligations and liabilities.
However, HMRC has two clear thresholds:
* Loans of £10,000 or less
* Loans above £10,000
For loans of £10,000 or less, there is no requirement for the director to obtain shareholder(s) approval on their director loan account.
For loans of more than £10,000, shareholder(s) approval is required before a director loan account can be set up. However, in many instances, director(s) and shareholder(s) are one of the same, but for the avoidance of doubt, a formal written approval should be filed nonetheless. In addition, for a directors loan account that exceeds £10,000, then you as a director must treat the loan as benefit in kind and deduct class 1 national insurance. HMRC are very clear about this in their loans to directors guidance.
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Do I pay Tax on a Director Loan Account?
You cannot take a loan from your company for an indefinite period without tax consequences. However, there is a defined period where the loan is free of tax and so long as it is paid back and your directors loan account is cleared, then there is no tax on a directors loan account. So when do you have to pay it back to avoid tax? Our article tax on a director loan explains all.
Do I pay Interest on a Director Loan?
There is no obligation for you as a director to pay interest to your company for a loan you have taken. However, if you fail to pay your company interest at the official rate of interest then your director loan account is treated as a benefit in kind.
Even if you pay your company a rate of interest lower than the official rate of interest then your director loan account is still treated as a benefit in kind. The rate of interest paid to your company must be at or above the official rate.
Note, that the benefit in kind charge only relates to directors loan accounts in excess of £10,000. If it is below £10,000 then there is no need to pay an official rate of interest, or any interest at all for that matter.
What If I lend my company money?
You can certainly make a directors loan to company and there are no limits as to how much you can lend your company. This is a common way for new companies in particular to obtain cost-effective risk-free funding. As a director, you are entitled to charge your company interest on any directors loan to company. It is advisable to charge a commercial rate of interest, similar to a rate of interest your company would incur on a commercial loan from a 3rd party lender.
The interest you charge your company is tax-deductible for your company (in other words it attracts corporation tax relief) and counts as personal income for you the director.
What Is Loan Recycling?
This is when a director loan account is repaid before the section 455 charge was payable and a new loan taken out immediately or within a certain time frame. Loan recycling is also known as bed and breakfasting. HMRC do not like this and introduced two new rules to counter this. These are known as the 30 day rule and the arrangement rule.
Director Loan Accounts Written Off
If a directors loan is formally written off by the company, then the outstanding amount is likely to be treated as a deemed dividend for the director and company alike. For the director, this means income (dividend) tax will become payable on any deemed dividend amount and national insurance will be become liable for both the director and company. If a section 455 charge has been paid, then this will be refunded in the event of a loan being written off.