Directors loans

When a director takes more money out of a limited company than he has put in (other than in the form of remuneration) it is classified as a director’s loan (and a benefit in kind if it exceeds £5,000). This can be paid to the director either as cash or the director charging personal expenses to the company.

When a director takes money out of a limited company it has special treatment and is referred to as a director’s loan account even though it is not always paid into a specified loan account.

Legal Position

The general rule under the Companies Act 2006 is that director’s loans are permitted provided that it has shareholder approval, which must be sought beforehand for loans over £10,000.

A company that gives a loan to its director(s) must also comply with the accounting requirements of Section 413 of the Companies Act 2006 which requires the company to disclose details of the size of the loan, the interest rate and any amount to be paid or written off (where the loan is considered to be irrecoverable).

Where more than one director is loaned money from the company separate bookkeeping entries must be kept for each loan.

Tax Implications

Where a limited company has loaned money to a director the company is required to pay 25% tax and interest on any sum that has not been repaid within nine months and one day after the end of the company’s corporation tax accounting period and is calculated on and paid with the company’s Company Tax Return.

When a director’s loan account has been cleared the company can reclaim the amount of tax that has been paid and this is known as “claiming relief”. The relief can be claimed nine months after the end of the accounting period in which the loan was paid off and must be made within four years from the end of the financial year in which the loan is repaid (six years if the loan was repaid on or before 31 March 2010). The relief is claimed on the company’s Company Tax Return.

Directors should also be aware that where the loan account is overdrawn there may be income tax and national insurance implications.

Where the director’s loan account is released or written off it is treated as the director’s net personal income. So if the director is a higher rate tax payer then he or she may have to pay the difference in addition to any national insurance contributions that are due.

There is no tax implication where a director lends money to the company (placing the loan account in credit) and withdraws all or some of these sums. However there may be income tax implications both for the director and the company and the interest should be paid gross.

There is also no tax implications for (i) certain small loans paid to participators (a person who has an interest in the company i.e. a shareholder or director’s spouse or civil partner) who are full-time working directors without a material interest in the company; and (ii) loans to participators for the supply of goods and services in the ordinary course of business provided that the company does not give longer credit than it would to normal customers.

Advantages

The most obvious advantage to a director’s loan is that it can help the director’s short term cash flow. Director’s loans are also used as part of a wider tax efficient strategy as directors will often take their remuneration as dividends throughout the year and either little or no salary thus creating a tax saving (particularly national insurance). The dividends are classified as director’s loans until they are declared as dividends at the end of the tax year.

Risks

A director’s loan account must be managed carefully and should not be abused for a number not least because HMRC is entitled to make enquiries about the loan account as part of any corporation tax compliance check.

The biggest problem for directors is with loans and dividends. Directors cannot lawfully backdate a dividend declaration to make a loan payment look like a dividend and when this happens and the company goes into liquidation or administration a claim can be made against the director to pay back the loans which could go back a number of years and could be substantial.

Further Information

Further information on director’s loans and their treatment is available from HMRC: http://www.hmrc.gov.uk/ct/managing/director-loan.htm and further information on the pitfalls is available at: http://www.bloomsburytaxonline.com/directors%E2%80%99-loan-accounts-%E2%80%93-common-pitfalls-and-traps/.