As a director of a UK Limited or incorporated company, if you have or are intending to borrow money from your company by way of a director loan, then understanding the potential tax on directors loans is imperative. If not managed correctly, you could get unknowingly stung with a director loan tax which takes a couple of forms, explained and discussed in this article.
The Basics Of A Director Loan
A director loan is when a director of a company either borrows money from their company or alternatively lends money to their company. The former is known as an ‘overdrawn’ director loan account, similar to a bank overdraft.
As the title suggests, a director loan can be taken or provided by a director of a company. It is quite common for directors to borrow money for personal cash flow, and lend money to inject funds into their company rather than the company borrowing money from a bank or financial institution that can be expensive and comes with personal risk(s).
What Tax Is Payable On Directors Loans?
Essentially, there are TWO types of taxes payable on your directors loan. Now, when we say a directors loan, we mean a loan from your company to you the director.
The first type of tax on directors loans is known as the section 455 tax charge.
The second type of tax on directors loans is known as the benefit in kind (BIK) charge.
Section 455 Tax On Directors Loans
The section 455 director loan tax is payable if you fail to repay the director loan back to your company within 9 months of your company’s financial year end. For example, if you borrowed £15,000 from your company on the 31st January, and your company’s financial year ends on the 31st March, you have until the 31st December in the same year (9 months after the financial year end) to repay the loan back to your company or pay a director loan tax of 32.5% on the outstanding loan amount, called the section 455 charge.
So in this example, you as the director would be liable to pay £4,875 as a director loan tax if you failed to repay the whole £15,000 by the 31st December.
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Benefit In Kind (BIK) Tax On Directors Loans
The benefit in kind tax on directors loans that is levied on the director personally. BIK’s are only levied on loans of more than £10,000, and only if interest at the official rate of interest is not paid by the director to the company.
For example, if a director borrows £20,000 from their company and pays interest at or above the official rate (this can be paid monthly, quarterly or annually) then the director would not be subject to the BIK tax on directors loans. If the director does not pay interest or pays below the official rate, then a BIK tax charge is levied on the director personally.
The BIK tax on directors loans charge is applied using the income tax rates. So, it could be 20%, 40% or 45%. In addition, the company will also have to pay Class 1 secondary national insurance on the loan interest at a rate of 13.8%.
Exemptions From The BIK Charge
There are TWO exemptions for a director from the benefit in kind charge. Firstly, any director loan (the director borrows money from their company) below £10,000 are not subject to a BIK tax charge.
Secondly, if a loan to a director is used to invest into another company (called a qualifying loan) then again, this is exempt from the BIK director loan tax. In this scenario, the director borrowing the money must generally hold more than 5% of the ordinary share capital in the company they are investing in, to ensure they get the BIK tax on directors loans exemption.