As a director of a company, you will probably have been told by your advisor at some point that you have an overdrawn director’s loan account. But, what does this actually mean?
What is a director’s loan account?
A company is a separate legal entity, so any money taken out by a director will normally be through one of the following methods:
- A salary with tax and national insurance deducted.
- Declaring a dividend which will be included on the director’s self-assessment tax return.
- Taking money out of the company with no formal documentation.
The third method of drawing money out is the one that will create a director’s loan account. Effectively, all that is happening is the company is loaning the director money.
As a loan, this is not declared as income on the director’s self-assessment tax return. However, there are measures put in place by HMRC to avoid this being abused. I explain the main measure in an example below.
How is a director’s loan account regulated?
Let’s say that Company A has a year-end date of the 31st March and, at that date, Director B has an overdrawn loan account of £50,000, created by money drawn from the company in the previous year. This £50,000 won’t go on his tax return, which means that no tax is payable.
However, HMRC have put legislation in place for the following circumstances:
- A director has an outstanding loan owed to the company at the year end and
- This isn’t repaid within 9 months and 1 day of the year end
If this happens, HMRC place a 32.5% tax charge on the balance of the loan so, using the above example, this would come to £16,250. This is payable with the corporation tax, which is 9 months and 1 day after the company year end.
The tax will be repaid to the company once the loan has been repaid, although this will result in the company losing £16,250 for at least 12 months!
How do you repay a director’s loan?
The main ways a loan would be repaid to the company would be either by the director injecting personal funds back into the company or by a dividend being declared to clear the loan account. This would need to be done within 9 months and 1 day of the year-end date to avoid an S455 charge.
I mentioned above that the balance of the loan isn’t included on the tax return, but there is an amount that may be chargeable on a director’s tax return as employment income.
If a director has a loan within the year and, at any point, this loan exceeds £10,000, then it will give rise to a benefit in kind. This is declared by the company on a P11D form and the amount will then be taxed on the director’s tax return.
Again, using the above example, assuming the director owed £50,000 for a full tax year and he paid no interest to the company on the loan, then a benefit in kind will arise. This is charged based on the official rate of interest, which at the time of writing is 2.5%. You multiply this by the loan amount, which would give rise to a benefit of £1,250. This will be taxed as employment income on the director’s tax return.
The above is just a very brief and basic summary of the tax consequences of a director being loaned money by the company.
If you would like more detail, please get in touch and we would be happy to chat through your situation.