Directors loan

With sole traders and partnerships, business and personal finances are interchangeable, and taking money out of the business is generally very straightforward with no tax implications. However directors who are also shareholders of a limited company cannot simply take money out of the company accounts. This must be paid as a salary through PAYE, as dividend payments or be taken out as a director's loan.

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What is a director's loan and how do they work?

Any money taken out of a company by a director, where it is not paid out as salary, dividends or expenses, constitutes a director's loan.

Records must be kept for any money borrowed from a company (or lent to a company) - this is known as a 'director's loan account'. At the end of the financial year, any money owed to the company (or vice versa) must be included in the balance sheet as part of the annual accounts.

Tax may need to be paid on a director's loan, in the form of:

  • Corporation tax- if the loan is over £10,000 and is not repaid within 9 months of the end of the relevant Corporation Tax accounting period.
  • Personal tax - if the director's loan is over £10,000. Also if interest has been paid below the official rate, further tax may be due.

How do directors' loans differ from dividends or salary?

A director who draws a salary must do this in the same way as if they are paying any other employee. Wage payments should be registered with HMRC and deductions should be made through PAYE for income tax and National Insurance contributions.

Dividends can be paid to director shareholders in line with the extent of any annual profits. Dividends are taxed differently to salary payments.

A director's loan is not considered to be a payment in the same way as salary or dividends and tax may not need to be paid depending on the arrangements. However it is vital that accurate records are kept, as director's loans are subject to their own tax rules.

When is a loan classed as a benefit in kind?

If a director makes personal use of any asset belonging to the business, this is known as a benefit in kind and must be declared for purposes of tax.

If a director's loan account exceeds £10,000 at any time, this will be considered as a benefit in kind. It must be reported on the director's self assessment tax return and will be liable for Class 1 National Insurance deductions and the relevant rates of personal tax.

What is 'bed and breakfasting'?

Corporation tax must generally be paid on director's loans. However if the loan is repaid within 9 months at the end of the relevant Corporation Tax accounting period, tax relief can be obtained which essentially means there is no corporation tax to pay.

If a director's loan is repaid within the 9 month period but is immediately taken out again (ie in order to purposefully avoid paying corporation tax) this is known as ‘bed and breakfasting'. In an effort to stop this practice, HMRC has brought in rules which mean that any director's loans over £5,000 which are repaid and then taken out again within 30 days will not be eligible for tax relief.

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