Does borrowing or lending to and from your company really matter? It does! Find out how your director’s loan is affecting your personal and business taxes.
What is a Director's Loan?
There are two types of director’s loans, you borrow money from your limited company, and you lend money to your limited company. So, what does this mean? Let us break it down:
Director's Loan Borrowing Money
One type of director’s loan is when you (as a director) would transfer money from your company that would not be classed as a salary, dividends, or an expense. In simpler terms, this means you would borrow money from your limited company that you would eventually have to pay back.
Director’s Loan Lending Money to a Limited Company
The other type of director’s loan is when you (again as a director) would lend your personal money to the limited company, for example, if the company has struggled financially, as many businesses did through the pandemic, or to cover any start-up fees, when initially setting up the company, or you may simply be expanding the company’s business.
How is this different from taking a salary or a dividend you may ask? Salaries and dividends are recurring payments made to the director and/or shareholders which do not have to be paid back into the business. Whereas a director’s loan would have to be paid back to the director or company depending on whether it was lent or borrowed by the director. Also from a taxation viewpoint, salaries and dividends are taxable in your personal tax return, whereas, one would think that the directors don’t have to pay taxes on a loan taken from the company, in fact, the next couple of sections will cover this aspect in detail.
How do director’s loans affect your business?
Director’s loans can be extremely useful to get you out of short-term financial troubles, for example paying off an unexpected bill you may have had. Eligible directors can borrow the funds from the company; however, it is worth keeping in mind though that a (corporation) tax charge of 32.50% will be payable if the loan is not repaid within 9 months from the borrow date, with interest being charged at the official rate (currently at 2% set by HMRC). The implication of tax is primarily dependent on the basis of when the director’s loan is repaid. Further, this tax can be refunded if the money owed is paid in future periods. Better tax planning including but not limited to the use of a certain proportion of salary (through PAYE) and dividends can help you save a significant amount of taxes.
Director’s Loan Checklist
What you should be thinking about when borrowing or lending from your company:
- Take out director’s loans only when necessary.
- Repay your director’s loan within nine months and one day of the company year-end if possible
- Aim to borrow less than £10,000, pay tax at a higher rate for dividends
- If you borrow £10,000 or more, you must report it on your self-assessment tax return and the company must treat it as a benefit in kind
- Wait at least 30 days between taking out different director’s loans
- If you lend to your company, ensure that both you and the company use the correct tax treatment
- Do not allow your Directors Loan Account to be overdrawn for extended periods
Are Director’s Loans worth it?
Director’s loans can be great to get you out of a sticky situation financially, but they require a lot of admin work and have complicated tax implications. One should avoid it unless there is no other option. But if you are still going to need a director’s loan, make sure you follow the procedure correctly in order to avoid any tax implications, also it's always handy to have a great accountant on your side.