Introduction -what is a director’s loan?

When you are a Director of a company, there may be a need at one time or another, for you to lend money to the company.

Alternatively, if the need arises, you may need to borrow money from your company.

The total amount of the Loan or advance, one way or the other, between you and the company, will become a director loan account.

In both cases, where you are the sole director of your own company, there is no need for a written director loan agreement. However, if you are part of a company with more than one director, an agreement may need putting in place, as there are other parties involved.

Director loan to company

When you lend money to the company, it can pay you back in the future. You can do this once the business has the funds and is in the position to do so. This loan from director to company will form part of your company’s Balance Sheet, if it is not repaid by the company year-end.

There is no time limit as such, and you can agree with your own company when it should repay you.

The company can also pay you interest on the loan and if it does, this will be a business expense. However, this interest would become taxable income in a personal tax context for the director. If you are the sole director of your own company there is no benefit in doing this.

Company loan to director

From a technical standpoint, it is not allowed under the Companies Act 2006 for companies to make a loan to a director or shareholder. That is unless shareholder’s approval is obtained first.

However, for directors who run their own company, many borrow money from their company all the time. Therefore, HM Revenue & Customs (HMRC) has two sets of potential tax effects that connect with such loans.

Essentially, a company loan to a director can arise where you take money from the company that is not either:

• A salary, dividend or expense repayment.

• The repayment of a previous director loan to the company.

A director loan can be quite a complex area. If you would like an accountant that is knowledgeable in subjects such as this, please have a read of how to change your accountant.

Tax effect 1 -P11D item -National Insurance for company and income tax for employee

The first tax effect relates to your personal tax.

There is a loan to an employee. in this context, a director is an employee:

This scenario will only apply where the amount that you borrow exceeds £10,000, at any time during a tax year.

Such a loan to director is a benefit in kind, and you need to report these on the PAYE year-end form P11D. The employer needs to work out the `beneficial loan interest’ on any such director loan. This will then need reporting on form P11D. The beneficial loan interest is the interest the borrower has not paid to the employer. This interest is therefore the taxable benefit in kind. You can use the rate of interest that HM Revenue & Customs (HMRC) publish. The current rate of interest that is in use is 2.5%. You will also need to report the loan interest benefit on your Tax Return. As part of this, you will pay tax personally at either 0%, 20% or 40%, depending on what your other personal income is.

Furthermore, the employer needs to pay Class 1A National Insurance (NI). This is calculated at a rate of 15.05% on the same calculated interest. The Class 1A NI is payable just once per year. It is due by 19 July after the previous 5 April.

As a director, if your business makes a loan to your spouse, HMRC will treat the loan as though it was to you. They have already thought of this one.

The tax-efficient way to deal with a loan to a company director

There is a more tax-efficient way to deal with a director loan, than declaring interest on form P11D. The method here is a company can charge interest to the director on the loan. When it does, there is no requirement to report the loan interest on form P11D. As mentioned, the current HMRC interest rate is 2.5% and this interest will be a cost to the director. When the director pays interest to their company, it will become income in the company. As a result, this extra income will increase the bottom-line profit, that is payable as dividends to the director.

Under this scenario, the tax cost is the 19% Corporation Tax (CT) on the interest. The CT will be payable on the director loan interest income. When you compare this to the loan and P11D method, there is 15.05% Class 1A NI, which is payable by the company and income tax, which is payable by you as the director. You will pay this either 0% but more likely 20% or 40%. Therefore, when there is a loan to a company director, it is much more tax-efficient for your company to charge the director interest.

Tax effect 2 -Section 455 Tax

The alternative to a loan to a director, is a loan to a shareholder:

There is a tax effect when:

• The company makes a loan to a shareholder (who in this case is also a director) during the financial year; and
• Where the shareholder (director) will not repay the loan within nine months and one day of the financial year.

To summarise:

• If the director’s loan account is overdrawn (the director owes the company money) at the company’s year-end, the company may need to pay tax.

• However, if the entire director’s loan is repaid within nine months and one day of the company’s year-end, the company won’t owe any tax.

• Any part of the director’s loan that is not repaid, will be subject to Section 455 Tax, which is calculated at 33.75% of the outstanding balance.

• The S455 Tax rate was previously 32.5% prior to 6 April 2022. Before 6 April 2016, the rate was 25%.

Section 455 Tax and how this works

If your director’s loan account was overdrawn as at 30 April 2022, it must be repaid by 1 February 2023. If it is repaid by this date, there will be no tax charge.

There can be further potential tax consequences. This occurs when there is a loan from one of your previous accounting periods that is not repaid by the end of the current year. Where there is a loan due at the end of your previous financial year, that has not been fully repaid by the end of the current year and Section 455 tax has not been paid on this previously, there would be a Section 455 charge due on that balance now.

The S455 Tax charge is 33.75% of the appropriate loan amount, as we set out above. Out of interest, the rate of S455 charge is the same as the higher rate tax on dividends. The rate is presumably set at this level to sway company directors from considering the option to take a loan for a longer time. Therefore, many directors who take a loan will attempt to repay this within nine months of their company year-end.

Please note, Section 455 Tax is refundable to your company. The tax will come back nine months after the financial year during which the loan is repaid to the company.

When a loan is not repaid in time and the company pays Section 455 Tax, in between the tax being paid and subsequently recovered from HMRC, the company has tantamount loaned the amount of tax to the Government.

Repaying the loan

When you come round to repaying the loan, you can either:

• Repay money back into your company bank account; or
• Allocate a salary or dividend payment against the loan. i.e., record a salary payment or dividend as taxable income but do not draw the actual cash in relation to this. In turn, this reduces or clears the loan balance.

Avoiding a Section 455 tax charge

The Section 455 charge will be avoided if the outstanding director’s loan balance is repaid or cleared before the corporation tax due date. This date is nine months and one day after your company’s year-end.

However, there are some anti avoidance rules in place. You should take care not to fall foul of these rules. These seek to ensure that any repayments of the loan are genuine repayments, as opposed to transactions designed to avoid the Section 455 Tax charge. Such transactions would include taking another loan very shortly after you had just repaid it.

The main rule is a 30-day rule and this comes into play within a period of 30 days of a repayment of more than £5,000 is made when the director borrows from the company again. This rule will render the repayment ineffective, where funds are borrowed again within 30 days. It also does not matter which comes first, the actual loan repayment or the further loan that one takes, the 30-day period will apply equally. This measure prevents a director from taking out a new loan and using it to repay all or part of the original loan.

Director loan examples

Example 1     

 John owes £6,000 to his company as of 30 June 2022. He decided to borrow all of this during the year to 30 June 2021. John then repays this by 31 December 2022. Therefore, there is no S455 Tax payable.

Example 2     

Zoe owes £6,000 to her company as at 30 September 2022. Previously she said she would repay this within nine months of the 2022 year-end. At the next company year-end (30 September 2023), Zoe’s director’s loan account decreases to being £4,000 still owed.

Therefore, the loan is not paid back in full as of 30 September 2023. Zoe’s company will now need to pay 33.75% (£1,350) of the £4K over to HMRC.

If Zoe’s company repays the £4K by 30 September 2024, the £1,350 will be refundable to her company on 30 June 2024.

Example 3   

Peter owes £10,000 to his company as of 31 December 2022. His company has already paid over 33.75% of this (£3,375) as S455 Tax.

The director’s loan increases to £15,000 by 31 December 2023. Peter anticipates this will decrease to £5,000 by 30 September 2024.

In this scenario, there will be no S455 Tax due. There is no tax due because the £5,000 loan that Peter takes during the December 2023 year will be paid back within nine months of the year-end.

The outstanding loan balance as of 30 September 2024 will be £5,000. Therefore, a further £5,000 of the loan is paid back in connection with the December 2023 year. This £5,000 will not receive S455 Tax relief, as the original £10,000 loan that Section 455 tax was paid on, relates to the previous year. Instead, the company will need to wait and see what the position is as of 31 December 2024. If Peter repays the loan in full or it reduces from the previous balance of £10,000, then the appropriate amount of S455 Tax will be refundable by 30 September 2025.

There are also further variations of the above examples and this can get quite confusing. If you have a good contractor accountant to guide you, they can ensure that the tax on any director loans, are reported, paid over and recovered correctly.

Final thoughts   

When you run your own company, there could be a) a loan from a director or b) a loan to a shareholder or director in one of your accounting periods. However, in scenario b) the borrower may be both of these. In this case, both tax consequences could apply.

It is key to take into account the guidelines above. If you do borrow from your company, please aim to repay it within nine months of the company year-end. When you have an extended director loan, please also consider paying your company interest as this is much more tax-efficient than declaring interest on form P11D.

If you are still unsure and you have a good contractor accountant, they will help you understand and guide you through all of the above.

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