Understanding director’s loans and their role in your business

directors loan

What is a director’s loan?

A director’s loan allows directors to borrow money from or lend money to the limited company for personal use, but not for salary payments, expense reimbursements, or dividends.

Director’s loans are common in small businesses where the director is also the owner. It is important to keep track of these loans and ensure that they are properly recorded and repaid to avoid taxation, legal or financial issues.

Here’s everything you need to know about director’s loans and how to manage them responsibly.

When and why might you borrow from your company?

You may choose to borrow from your company through a director’s loan because they are easy to access – you don’t need to go through external credit checks and approvals. They are also tax-efficient if you repay them within nine months of the companies’ financial year end and they offer flexibility, as you can both lend and loan money of any amount to your company.

You may decide to draw a director loan and repay via a ‘paper’ dividend in a later year when your income is lower or tax rates have reduced.

Benefits of director’s loans:

  • Easy to access
  • Tax efficient
  • Flexible lend or loan
  • No legal loan limit
  • Less impact on the company’s credit rating than a salary or dividend

How much director’s loan can you borrow?

The amount of director’s loan that a director can borrow has no legal limit.

However, you must obtain the approval of any company shareholders and carefully consider how much the company can afford to lend you.

If the loan exceeds £10,000 this will be classified as a benefit in kind when it comes to taxes (unless a market rate of interest is paid). This means that you will have to fill out a P11D form with HMRC and declare it on your self-assessment tax return.

You must also keep a record of any money you borrow from or pay into the company – this record is usually known as a ‘director’s loan account’.

How soon must you repay the director’s loan?

To avoid facing a heavy tax penalty you must pay the director’s loan back within nine months of the company’s year-end. Any unpaid balance will be subject to corporation tax (section 455 tax). Fortunately, the company can claim this tax back once the loan is fully repaid – however, this can be a lengthy process.

The repayment schedule for a director’s loan can vary depending on the terms set out in the company agreements. As long as it is repaid in full within 9 months of the company’s year-end you should avoid any tax complications.

Do I have to pay tax on a director’s loan?

You may have to pay tax on director’s loans if you have taken longer than nine months to repay the loan and have been charged corporation tax.

Your personal and company tax responsibilities depend on whether the director’s loan account is:

  • Overdrawn
  • In credit

It is up to the company what interest they charge on the director’s loan. If the interest charged is lower than the official rate then the discount must be treated as a benefit in kind and the director will be taxed on the difference between the official rate and the rate they’re paying.

Effectively manage your business accounts

Director’s loans can be a really helpful tool for managing cash flow or covering personal expenses, but it is important to handle them responsibly and by legal requirements.

Are there any potential pitfalls?

If the company fails, the liquidator (or official receiver) will require you to repay the loan.

Also, if the company has minimal profit reserves, funders may argue the business owner is withdrawing more cash from the business than it can afford.

At 360 accountants we can help you to keep accurate records and effectively manage loans to avoid any financial or legal issues. We can also advise on the taxation implications of dividends v salaries v loans. Contact us on 01482 427360 for more information.

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