How Much Does a Director Loan Cost?

Author: George Ian Hope BAcc(Hons), MSc(IT), FCCA, CGA, CPA

Managing Director – QAccounting Limited (www.qaccounting.com )

https://www.linkedin.com/in/gihope

Ian is a general practicing member of the Association of Chartered Certified Accountants with fellowship status (FCCA). He is also a member of the Certified General Accountants Association of Canada (CGA), and a member of Chartered Professional Accountants of Canada (CPA).

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Director loans are a popular yet often misunderstood financing method used by small business owners. If you’re a company director who has taken, or is considering taking, money out of your company (that isn’t structured and subject to tax as: a salary, dividend, or expense reimbursement), then you are effectively using a Director Loan.

While this is a flexible way to access company funds, HMRC has strict rules governing how and when these loans need to be repaid, along with potentially significant tax implications. This article discusses at a high level the cost of a director loan, including a consideration of S455 Corporation Tax, Loan Interest, P11D Income Tax, and also the associated administrative responsibilities.

What is a Director’s Loan?

A director’s loan balance occurs when a director takes money from the company that is not a salary, dividend, or legitimate expense. This amount is typically recorded in the accounts in a Director Current Account (DCA), or other equivalent control account.

There are two main scenarios:

• Overdrawn Director Current Account: When a Director withdraws funds from the business more then what has already been processed as a salary, dividend, or expense.
• Loan to Director: Any value of funds withdrawn from the business by a Director in excess of what they have put in.

In practice the DCAs that we manage on behalf of our clients consist of three main parts:

• Salary Control Account – This is used to compare the values of salary processed for a Director against the payments withdrawn.
• Expenses Control Account – This is used to compare the values of expenses processed for a Director against the payments withdrawn.
• Director Loan Account – This is used to compare the value of funds withdrawn from the business (which are not salary / expenses recorded earlier) against the value of funds put into the business.

While there is no statutory or other requirement to split out the values in this way, we find that doing so significantly helps with the accurate classification and reconciliation of this information.  In particular it forms the basis for requesting missing source documentation from our clients in a way that helps them to understand what we are asking for, and why this information is required?

Why Do Director Loans Matter?

Using and correctly accounting for Director Loan balances matters because, if you fail to repay them before certain deadlines or account for them incorrectly, then this could:

• Trigger additional taxes,
• Result in interest charges,
• Create additional reporting obligations, and
• Draw additional and unwanted scrutiny from HMRC.

Key Taxation Impacts of a Director Loan

1. Section 455 Corporation Tax (CT)

 The most significant “up-front” tax implication of a director loan is S455 Corporation Tax.

 Section 455 of the Corporation Tax Act 2010 imposes a tax charge, currently at 33.75%, on the company, on the aggregate value of director loan balances which have not been repaid within nine months and one day after the end of the company’s accounting year end.

However, it is possible to get this money back (eventually) providing that the Director Loan is repaid!  In order to recover these funds a S458 tax reclaim must be submitted, and the earliest that HMRC will be willing to repay this money is 9 months and 1 day after the end of the accounting period in which the loan is repaid.

The fact that this tax can be repaid to the Company in the future (providing that the Director Loan is repaid) means that S455 CT is effectively a “cash flow impact”, or a period of time for which the company does not have access to this money.

So why would HMRC create a repayable tax? – They have done this to try and protect against the risk of Directors removing money from a company (which has not yet been subject to tax), and then cancelling or not repaying these loans.  So HMRC tax all loans (withdrawals of funds from the company which have not yet been taxed) and which have not been repaid within 9 months of the year end.  And if the Director never repays these loans, then it doesn’t matter to the same extent from HMRC’s perspective, because they have already taxed this money!

2. Interest and Corporation Tax

Like any other type of loan it is important that the company also charges interest on this funding at “market levels”, otherwise HMRC may argue that the loan should be treated as a taxable benefit in kind for the Director.

This interest should either be paid into the business by the Director personally, or added to the outstanding value of the loan.

However, there are a number of important taxation considerations with respect to this that you need to be aware of:

a) What are “market levels” of interest? – Thankfully HMRC do provide guidance with respect to this area and they have published market rates which must be applied to loans to ensure that they are not treated as a taxable benefit HERE.

b) The interest which is paid to the company is taxable income for the company – Any interest that the Director needs to pay into the company is taxable income for the company, and therefore will be subject to Corporation Tax at the rate which applies to the company (currently between 19% and 25%).

c) Any interest that you pay to the company is still indirectly your money (if you own the company)! – It is worth pointing out that if you are also a shareholder in the company to which you are paying interest to then you are indirectly paying yourself, to the extent that you own the company (based on the percentage or your shareholding). So these funds are still available to be withdrawn again from the company by you in the future, subject to tax of course depending on the method by which you withdrawn the funds (salary, dividends, expenses).

These are very important points because they highlight that the true cost of taking out a Director Loan is actually the taxation cost of doing so, including the Corporation Tax on the Interest, and the tax on any interest you subsequently withdraw from the business again in the future.  The “post tax” interest therefore ends up being another “cash flow impact” (similar to S455 tax described above) if you also own the company.

And therefore, this highlights why Director Loans can actually be a very favourable and cost-effective method of obtaining finance, when compared to the alternative of borrowing funds from an external provider.  When obtaining a loan externally you wont be subject to tax, BUT you will have to pay the full amount of interest to the provider of the loan and you will never be able to get this back!

3. P11D and Benefit in Kind (BIK) Taxes

If the company provides a loan of over £10,000 to a director without charging interest, or charges less than HMRC’s official rates of interest (discussed above), then HMRC treat the Director as receiving a taxable benefit in kind.

There are a number of important taxation considerations with respect to this that you need to be aware of:

• The director pays Income Tax on the benefit – A Director is charged income tax on the shortfall between the value of interest calculated using the market rates as defined by HMRC, and the interest they have already been charged (if any). This “benefit value” is added to the Director’s other income to determine the rate at which they need to pay tax.
• The company must report the benefit on a P11D – A P11D return must be submitted for the Director by the company before the 7^th July deadline.
• The company must pay Class 1A National Insurance on the benefit – The company must also pay employers national insurance on the value of the benefit. And the rates for Employers NI have recently been increased by the Labour Government to 15%!

However, while it is important to be aware of these rules, the obvious way to ensure that you don’t need to do any of these things, is to ensure that interest is charged by the company at the market rates as defined by HMRC!

Bed and Breakfasting Rules

Having read the above, the more astute will have realised that the best way to avoid most of the compliance and tax requirements outlined above is to ensure that Director Loan balances are repaid within 9 months of the company year end.  As in these cases it is effectively possible to temporarily borrow money from the company and then pay this back within the time limits to ensure that you are not subject to tax and other filing requirements.

And in many respects, this is true!  Although strictly speaking interest should still be charged by the company for the period of the loan regardless, and taxed accordingly.

However, it is important that when you do repay these loans that there is no intention to take out new loans at the time of the repayment, otherwise you may fall foul of the bed and breakfasting rules.

These are rules which HMRC have created to try and prevent scenarios where Directors repay the loan before the 9 month deadline to avoid paying S455 tax, and then take out a new loan shortly afterwards.

They include the following:

• The 30-day Rule – Where a Director has repaid at least £5k in director loans, and then immediately withdraws at least £5k within the same 30-day period. Then HMRC will treat the excess of withdrawals over repayments as still taxable for S455 tax purposes.
• The Arrangements Rule – Where the value of the loan exceeds £15k, and there are “arrangements” in place to take out at least another £5k in new loans at the time of the repayment, then HMRC will treat the entire amount as still taxable for S455 tax purposes. And unlike the 30-day rule, there is no time limit on these provisions.

In practice it may be difficult for HMRC to prove that the Director had intentions to take out a new loan at the time of the repayment of the old one, unless there is evidence of some kind to verify that these “arrangements” existed.  But it is better to be safe and not repay director loans unless there is no intention to take out new loans at the time of the repayment.

In both cases the above rules don’t apply where the Director declares a dividend of bonus to help repay the loan, because they will already be subject to additional income tax on these taxable withdrawals of funds form the company.

Can QAccounting Help Me?

Yes, we aim to be the UK’s Premier Online Accountancy and Tax Accountant, and we are here to help you every step of the way, whether you need to understand the rules in greater detail or need advice about next best steps.

Please give us a call, email us, or contact us ONLINE to speak to a member of our Accounting team without delay!