Director’s Loans Explained

What is a director’s loan?

A director’s loan is when a company’s director borrows money from the company for personal use or other purposes unrelated to salary, dividends, or business expenses. This type of loan is recorded as an asset for the company and a liability for the director until it is repaid.

Why would a director borrow money from my company?

Directors may choose to borrow money from their company for various reasons. One common reason is to cover personal expenses or financial needs without seeking external financing from banks or other lenders. This can be convenient and flexible for directors who have access to company funds and need short-term liquidity.

Additionally, borrowing from the company can be more straightforward compared to traditional borrowing processes, as it may involve fewer formalities and paperwork. Directors may also use company loans for investments or to manage temporary cash flow shortages, especially if they believe they can repay the loan within a reasonable timeframe.

What is a director’s loan account?

A director’s loan account is a record maintained by a company to track transactions between the company and its directors. It represents the balance of money owed by or to the director based on financial transactions such as loans, withdrawals, or repayments. If a director borrows money from the company, the amount is recorded as a debit (money owed to the company) in the director’s loan account.

How much can a director’s loan be?

A  director’s loan can vary depending on company policies. These policies may be influenced by a number of factors, including tax and National Insurance implications.

How much interest does a loan charge?

The interest rate charged on a director’s loan can vary depending on several factors:

1. Company policy – some companies may charge no interest or a nominal interest rate on a director’s loan, especially if the loan is provided for short-term or temporary purposes.
2. Agreement terms – if interest is charged, the rate maybe agreed upon and documented in the loan agreement between the company and the director. This rate can be fixed or variable based on the terms negotiated.
3. Commercial rates – in cases where a company charges interest on a director’s loan, the rate may be based on prevailing commercial interest rates or rates that are deemed fair and reasonable for internal company borrowing.
4. Official rate of interest – HMRC reviews the official rate of interest on a quarterly basis but normally sets a single rate for the whole tax year. It is used to calculate the cash equivalent of the loan as a taxable benefit

How soon must it be repaid?

The repayment timeline for a director’s loan will change depending on the terms agreed upon between the company and the director. Typically, director’s loans are expected to be repaid within a reasonable timeframe, which can range from a few days to a few years. The repayment schedule maybe outlined in a loan agreement and may include regular instalments or a lump-sum repayment by a specified date.

A director’s loan and tax implications

A director’s loan can have implications:

• Tax on beneficial loans –  if a director’s loan is interest-free or has a very low interest rate, the company may be liable to pay National Insurance on the deemed benefit provided to the director, and the director may be liable to pay income tax on the benefit. This benefit is calculated based on the official rate of interest and the loan amount itself.
• S.455 tax charge – if a director’s loan is not repaid within nine months and one day of the end of the accounting period in which the loan was made, the company may be subject to a tax charge under Section 455 of the Income Tax Act 2005. This tax charge is temporary and can be refunded once the loan is repaid or cleared.
• Interest  – if the company charges interest on a director’s loan, the interest received is taxable as income for corporation tax purposes.
• Recovery of bad debts – If a director’s loan becomes unrecoverable and is written off by the company, this can potentially be treated as a deductible expense for corporation tax purposes. However, the director would be deemed to have received taxable income.

It’s important for companies and directors to be aware of these tax implications and to comply with tax regulations related to director’s loans to avoid unintended tax liabilities or penalties. For more information or help, please contact your local Perrys branch.

FAQs

Can a director’s loan be interest free?

Yes, a director’s loan can be interest-free if the company and director agree to such terms. However, benefit-in-kind tax implications may arise from providing an interest-free loan.

What happens if I can’t pay my director’s loan?

If you are unable to repay your director’s loan, it could lead to potential tax implications for the company, such as being subject to tax. You and the company may also impose penalties or interest for late repayment. In more serious cases, the company could pursue legal action to recover the outstanding loan amount. 

What are the advantages of a director’s loan?

1. Convenience – directors can access funds quickly and easily without the formalities associated with traditional borrowing from external lenders.
2. Flexibility –  the terms of the loan can be negotiated directly between the director and the company, allowing for flexibility in repayment schedules and interest rates.
3. Cost savings – if the loan is interest-free or carries a lower interest rate compared to commercial loans, it can result in cost savings for the director compared to borrowing from other sources.

What are the disadvantages of a director’s loan?

1. Tax implications – interest-free or low-interest director’s loans can result in tax liabilities for both the company and the director.
2. Financial risk – directors may face personal financial risk if they are unable to repay the loan, potentially damaging their relationship with the company and affecting their financial stability.