A contractor’s introduction to Director’s Loans

*Please note the information in this article may be out of date

There may be a time when you need to loan money to or borrow money from your own Limited Company. Now you may think it’s your company and you can do what you want, but director’s loans are wrapped up in fiddly bits of legislation and when borrowing cash from your company, care must be taken. You must ensure that you fully understand the tax implications before you take any kind of loan from your business.

Here we give you an introduction to director’s loans, what they are, what the rules are, and how to use them in the most tax efficient way.

Borrowing money from your Limited Company

directors loan, as defined by HMRC, is when you or a family member take money from your company that is NOT either of the following:

• a salary, dividend or expense repayment
• money you’ve previously paid into or loaned the company

This Guide was written by Patrick Gribben, contractor and freelancer Tax Expert at Intouch Accounting. Patrick now writes for Listentotaxman.com on matters relating to contractor and freelancer tax. He and his colleagues are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Intouch Accounting website for contact details.

This Guide was written by Patrick Gribben, contractor and freelancer Tax Expert at Intouch Accounting. Patrick now writes for Listentotaxman.com on matters relating to contractor and freelancer tax. He and his colleagues are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Intouch Accounting website for contact details.

There are many reasons why you may need to take a loan from your company, such as to finance the purchase of a house or to fund a sudden unexpected expense. However, it is notrecommended that you take out a director’s loan unless it is absolutely necessary.

It’s important to remember that your Limited Company is a separate entity with its own responsibilities and legal obligations. The funds in your business bank account do not belongto you, they belong to the business. As the director, you can take money out of the company at any time, but any money taken from the business bank account that does not relate to a salary, dividend or expense repayment will be classified as a director’s loan.

How to withdraw a director’s loan

Withdrawing the director’s loan is simple enough. As it is your business you can simply withdraw the money from the business bank account without declaring it as a dividend or paying it as a salary.

It’s worth noting that some contractors may unwittingly end up with a director’s loan in this way if they try to distribute a dividend when there are not enough profits in the business to declare one.

Recording director’s loans

It’s vitally important that you keep a record of any funds you borrow from your company. Thisrecord is known as a director’s loan account. Your director’s loan account should record any cash withdrawals from the company that you’ve made as a director and any personal expenses which were paid with company money. You can find more information on business expenses in Intouch Accounting’s guide to expenses.

Your director’s loan account must contain evidence of all transactions involving both your personal and company’s finances to stand up to scrutiny. HMRC will review your director’s loan account through your company’s annual tax returns to ensure guidelines are being followed.

Tax implications

Directors can take out tax-free loans from their company for a specified period. However, there are some important rules to consider on these loans. One is the length of time you can borrow the money without being taxed on it, the other is the amount you can borrow as a director before it’s considered a benefit in kind.

The length of time you can borrow

Before the loan is issued, it’s important to note that the loan must be repaid within nine months and one day of your company’s year-end. If you fail to repay the loan amount by the deadline, any outstanding loan amount that is not repaid is subject to a supplementary Corporation Tax charge, known as S455 tax, at a rate of 32.5%.

As an example, if you took a loan of £5,000 on 2nd March 2019, and this was still outstanding at the company’s year end of 31st March 2019, you will need to pay HMRC £1,625 in additional Corporation Tax if the loan is not repaid by 31st December 2019.

Once the loan is repaid, the Corporation Tax on the loan amount can be reclaimed, however,this can’t be done until nine months after the end of the accounting period in which the loan was paid off, and getting your refund can be a very lengthy process if there’s no corporation tax liability for that period against which the repayment of S455 tax can be set. If you chooseto withdraw a director’s loan from your Limited Company, it’s best to ensure you can repay it within HMRC’s timeframe.

While we recommend your accounts and Corporation Tax returns are filed as soon as possible after your company financial year end, the Corporation Tax payment deadline is 9 months after this. This would allow you additional time to repay the loan therefore avoiding the additional Corporation Tax.

How much can you borrow?

While it is your company and therefore there is no limit to how much you can withdraw,  anything over £10,000 is classed as a benefit in kind.Benefits in kind are any personal benefits received from your company, such as an interest free loan, and this is therefore taxable. They must be declared to HMRC using a P11D form and additional income tax plus class 1A National Insurance at 13.8% will be applied to the loan amount.

Should you need a loan, best practice is to keep it below £10,000 to avoid additional tax and National Insurance and if possible, repay the loan in full before the end of your company financial year.

Repaying a director’s loan

To repay your director’s loan, simply transfer the money back into the company bank account or allocate a salary or dividend payment against the loan to reduce the balance.

It’s recommended that you do not take out another director’s loan immediately after repayingone. HMRC judge this as a tax avoidance tactic known as ‘bed and breakfasting’. This is a method that directors sometimes use to avoid tax; by repaying their loan before the companyyear end to avoid penalties, only to take it out again immediately without any real intention ofever repaying the loan. In addition to repaying the loan you need to ensure that there is a gap of at least 30 days before you take another loan from the company.

Clearing a director’s loan

Most directors who take out a loan have sincere intentions. However, circumstances such asa failure to find a contract, sudden termination of a project or a personal emergency can impede company profits and leave the director unable to repay. Your company can write off adirector’s loan, but there are tax implications that must be considered and the loan must be formally waived.

A company can clear or release a director’s loan by distributing a dividend if there are reserves available. For income tax purposes, the amount is treated as a dividend with the usual tax liabilities and will need to be included on the director’s self-assessment tax return. Class 1A National Insurance will also be payable by the company on the amount of the loan written off.

Loaning money to your Limited Company

Loaning money to your company is an easier process than borrowing. Particularly when you start a business there are initial costs such as insurance premiums, website packages, stationary and accountancy fees that are necessary to get your business off the ground.

Loaning yourself the money from personal funds can be beneficial while business takes off, and the good thing is, you won’t pay any Corporation Tax on the money you lend to your business.

Just as with borrowing money, it is important that you keep a clear record of the money you are lending, and if you choose to charge interest, this can be classified as a business expense for the company and a personal income for you. You will need to declare the interest income on your self-assessment tax return and you will be taxed on this.

Next steps

Director’s loans can be a minefield. If you’re a Limited Company contractor and think you might need to take out a director’s loan, we recommend speaking to a professional accountant to help weigh up the pros and cons before deciding to do so. Due to the tax implications it’s wise to only withdraw one if you really need it.