Directors loan accounts. Use it, but don’t abuse it!
I was recently asked by a client whether he could take out a directors loan from his company, instead of drawing a salary or paying dividends. Its not an uncommon question and in fairness it’s something that did used to work. Sort of…
For those of you who don’t want the detail – let me be short.
NO – YOU CAN’T DO THIS AND YOU WILL GET STUNG FOR TAX IF YOU ATTEMPT IT. DON’T DO IT
There are essentially two facets to the question:
- Do you get taxed personally
- Does the company get taxed
Do you get taxed personally?
Essentially, if the company grants you personally a loan, without interest being paid, it is treated as a benefit in kind. Basically you are getting an economic benefit from the company, but not paying any tax on it. If this happens you pay income tax on the value of the benefit (which is actually the interest you would have paid if interest had been charged on the loan). The company also pays a type of national insurance called class 1a.
Under £10k, you are correct that the loan is treated as an exempt benefit. As a result there would be no income tax or company national insurance to pay.
Does the company get taxed?
This is the real mine field. There are two main issues here:
1 – Section 455 CTA 2010
Section 455, Corporation Tax Act 2010 is a key anti-avoidance weapon for owner-managed companies. Without it, owner managers could easily avoid a tax charge by arranging for ‘their’ company to lend them funds (as opposed to paying a ‘taxable’ bonus or dividend).
However, s455 levies a tax charge, equal to 32.5% of the loan, where a company makes a loan to you or one of your family members. In most cases, the s455 tax liability falls due nine months after the end of the accounting period in which the loan is made. The company is able to recover the s455 tax if and to the extent that the loans are repaid.
So basically – if the company loans you money, it gets charged tax on that loan as if it was a dividend at the higher rate. If you repay that loan you will get the tax back. If you never repay it you won’t. HMRC also charge you interest during this period and you can never reclaim it.
Under personal earnings of £100k there is no tax benefit, but much more work involved.
Some people have tried to get around this by paying back the loan and then drawing down another loan – this is what is known as “bed and breakfasting”. HMRC are all over this and have rules in place to stop this.
2 – Does the loan ever need to be repaid
Even if you decided that S455 was OK (not sure why you might, given it’s almost always a bad idea), essentially, eventually yes you do need to repay the loan in some way. When you come to wind up the company there will be an amount outstanding to you. To close down the company you will need to either
- Repay the loan (getting back the tax levied, but not repaying the interest that HMRC charged)
- Write off the loan (It will be treated then as income by HMRC – the type of income will be employment income and therefore you will, as well as needing to pay income tax, you will need to pay national insurance personal, and in the company)
- Close the company in an insolvent state – you run the risk of a HMRC investigation with charges of fraudulent trading (which is a criminal offense)
There are lots of other tax rules that interact on winding up such as the Targeted Anti Avoidance rule (the so called anti-phoenixing rules) which further lock down this situation.
With the above in mind I would recommend against taking out a directors loan. You could loan yourself the money in the short term and then repay it using a dividend at the end of the year, but to be honest – you might as well just pay yourself a dividend in the first place and avoid the unnecessary loan step.
Does it ever work?
There is once circumstance where the S455 doesn’t apply and that is where the loan is under £5k, but you still have to think about how that loan will be repaid in the future.
One final thing is that the loan will also need to be disclosed in the accounts, which are on public record, but also with HMRC as well. I’m not sure if this is an issue for you. Personally it wouldn’t bother me but it’s something else to be aware of.
There is some useful additional information here:
https://www.gov.uk/directors-loans/you-owe-your-company-money
What can I use directors loans for
There’s no denying that directors loans are incredibly useful. Of course there are two sorts of directors loans. Loans where the director owes the company money – this is the subject of the above post.
The other, which is incredibly useful at times, is where the company owes the director.
Being able to generate a large directors loan account that the company owes you has potentially lots of benefits.
For starters you can charge interest on that loan. For basic rate tax payers you can receive up to £1,000 personally tax free. Meanwhile, your company can claim this cost against its corporation tax bill.
Furthermore, if you manage to arrange your affairs so that you have no taxable income from a salary, you can claim another £5k (note this doesn’t mean you can only get this if your earnings are nil, its just how you arrange things – we can help with this if you want).
Lets not forget – anytime you repay a loan to yourself, there is not income tax to pay on it.
Its about more than tax…
Directors’ loans are useful in the early stages of the business. I’m often asked what clients should do in terms of paying for things before they’ve had their first invoice paid. The answer is relatively easy
- Pay for things yourself and keep a track of it (a bit of a pain admin wise)
- Lend the company some money, and get the company to pay for it. Then have the company repay you later on when it has the funds.
The key point here is not to set up the company with lots of share capital (unless you need to for other reasons), which is what I find many clients thinking they need to do. A quick phone call to me tends to get them on the right track.
In summary
Don’t, if you can avoid it, try and pay less tax by loaning yourself money from a company – it doesn’t work – in fact it works out quite expensive.
You can borrow money in the short term, so long as you have a plan to pay it back. Keep on top of it though – don’t forget about it as it will catch up with you
Do think about directors loans from a tax planning perspective – particularly from a profit extraction perspective.
