While there are encouraging signs that the UK economy is recovering, there may still be some challenges ahead in the next few months. In these difficult times, many directors will look towards their director’s loan accounts as a form of emergency income as and when required. This is one of the benefits of a limited company, although there are various tax implications to consider.
Definition of a director’s loan
The official definition of a director’s loan, according to HMRC, relates to funds taken from a company which are neither:-
- Salary, dividend or expenses
- Repayments of loans to a company
This type of loan facility must be approved by a resolution of the company’s members, with all records kept up-to-date. Where payments have been made without the consent of shareholders, the decision can be challenged and could end up in the courts. So, now we know what defines a director’s loan account and who can authorise it; what are the tax implications for the director?
Items covered by a director’s loan account
On the surface, the rules regarding directors’ loan accounts are relatively straightforward. The items covered include:-
- Cash withdrawals from the company
- Personal expenses paid using company funds
As a company director, it is perfectly acceptable to be reimbursed for business-related expenses you paid out of your funds. Sometimes, it can be challenging if the expenses could be construed as personal costs. Any expenses charged to the company, paid personally by a director, must pass the personal expense test before being reimbursed.
According to HMRC, business expenses relate to the purchase of products or services that help keep a business running. For example, the full cost of a mobile phone bought for personal and business use could not be offset. However, assuming the usage split was 50/50 it would be legitimate to offset 50% of the cost of the mobile, leading to partial reimbursement for the director.
Tax implications of a director’s loan account
There are two critical dates regarding tax implications regarding an overdrawn director’s loan account. These are the following:-
- Company year-end date
- Nine months and one day after the company year-end
In a perfect scenario, any overdrawn loan account would be repaid before the company year-end. However, if the debt is repaid within nine months and one day after the company year-end, there are no tax implications.
Maintaining an overdrawn director’s loan account
If the director’s loan account is still in debt after nine months and one day from the company year-end, it can get complicated.
Corporation tax liability
To discourage long-term director loan account deficits, HMRC charges 33.75% (rate for 2024/25 tax year) interest to the company on overdue loan account balances. This is known as a Section 455 (S455), and the interest charge is reimbursed to the company once the director’s loan account has been repaid. However, with one eye on cash flow, it is essential to note that any HMRC charge could take as long as nine months after the end of the accounting period in which the loan was repaid.
It is safe to say that HMRC is attempting to make overdrawn directors’ loan accounts as unattractive as possible.
Benefit in kind
In what could be described as a double whammy, failure to repay a director’s loan by the deadline could also result in a personal tax charge under the benefit-in-kind regulations. Any outstanding loan will be treated as a benefit-in-kind if the following conditions are met:-
- The outstanding loan was a minimum of £10,000
- No interest was being paid on the outstanding monies OR
- The rate of interest fell below the HMRC official rate
Consequently, the director must complete a P11D form showing the deficit as part of their self-assessment tax return. The outstanding funds would be added to their annual income and taxed accordingly, with the company also liable for national insurance. These funds would be collected as part of the PAYE system.
Loan written off
If the director’s loan account debt were written off by the company and the company reclaimed corporation tax paid on the outstanding amount, this liability would be passed to the director. For example, if the outstanding amount were £20,000, the tax charge would be £6750. Consequently, the director would need to show the written-off loan of £20,000 on their tax return, which would attract a tax charge of 33.75%. In effect, the written-off loan amount is deemed a dividend payment and taxed at a higher rate.
Repayment of a director’s loan
The obvious means of repaying a director’s loan is from personal funds within nine months and one day of the company’s year-end. However, there are alternative means of repayment which include:-
Company dividends
Interim and final dividends must be paid from distributable reserves within nine months of the company’s year-end. This ties in perfectly with the schedule for repaying an outstanding director’s loan. In what would effectively be a bookkeeping exercise, the director would not receive the dividend payment, as this would be used to offset their loan deficit.
Salary payments
Similar to company dividends, regular (net) salary payments can be used to offset an outstanding directors’ loan account balance. But, again, this would be another bookkeeping process, and the director would not receive the salary payments.
Expense claims
An additional form of income which can be used to offset a director’s loan is legitimate company/business expenses. In some cases, you may be able to go back several years when reclaiming expenses, but that would depend upon the type of claim.
Exemptions from an S455 tax charge
There are some scenarios where the director and company would be exempt from an S455 and additional tax charges. These include:-
Director’s loan account offset
For example, if a husband and wife are directors of the same company, it may be possible to offset a surplus on one account against a debit on the other.
Ordinary course of business
While not a common scenario. If the director’s loan account was in deficit in the ordinary course of business, such as moneylending, it may be exempt.
Supply of goods/services
Where the deficit relates to the supply of goods and services in the ordinary course of business, any director’s loan account deficit may be exempt from an S455 charge.
No material shareholding
Where an individual, whether a director or a full-time employee, has no material interest in the business (no more than 5% of the ordinary share capital), loans up to £15,000 may be exempt from S455 tax charges.
Bed-and-breakfasting
In a term known as “bed-and-breakfasting”, it is crucial that you resist the urge to repay your director’s loan account deficit just before year-end and then withdraw funds one day into the company’s new financial year. This is because, under HMRC regulations, loans cannot be re-borrowed within 30 days of repayment.
Conclusion
Unfortunately, director loan account deficits can be relatively complex and ultimately lead to personal and company tax charges. There are no tax repercussions if funds are repaid within nine months and one day of the company’s year-end. However, the practical impact on company cash flow should also be considered whether repaid on time or beyond the deadline.
If you would like to discuss the tax implications of a director’s loan account or other business matters, please contact us, and we can look at the situation in more detail.