Borrowing from your limited company – director loans

You are allowed to borrow money from your own limited company but there are various rules and tax traps to be aware of which we discuss in this article.

You can’t take a loan from your company indefinitely without causing tax issues (if you could, many people would do this instead of paying themselves salaries & dividends!).

If you have loans that total more than £10,000, they need to be approved by the company shareholders – if you are both the shareholder and director of your company, this is obviously not an issue, but it’s still good practice to document the loan.

 

We hope you enjoy this article from our archives. As tax rules change a lot over time, the information in this post may not be current, but we hope you still find it interesting.

 

 

Section 455 tax

The first issue to be aware of is the Section 455 tax charge, also known as s455.

The majority of small limited companies will be classified as a ‘close company’ – this is usually a company that is privately owned and controlled by 5 or less participators (directors / shareholders).

Any loans made by a close company to a participator will be subject to the s455 tax charge rules which work as below:

• The total participator loan balance owed to the company at the company year-end will be taxed at the current s455 tax rate (32.5% for 21-22) [please note that the s455 tax rate has increased to 33.75% from the 22-23 tax year]
• However, if the loan is fully repaid within 9 months of the company year-end, full tax relief is given, meaning no s455 tax charge is due

Any s455 tax paid will be refunded by HMRC further down the line once the loan is repaid – however there is quite a delay on this process as you can’t apply for the refund until 9 months after the year end in which the loan has been repaid.

In our experience, even once the application for the s455 tax refund is submitted to HMRC, it can take them a long time to repay the tax – for this reason we tend to recommend avoiding director loans if possible.

You may think it is tempting to repay a director’s loan just before the company year end and then pay a new loan to yourself shortly afterwards – however HMRC have anti-avoidance tax rules whereby in these circumstances it would usually be seen as one continuous loan, so this is not a route we advise.

 

Let’s look at some examples of how director loans and s455 tax work:

Example 1

Joe Bloggs borrows £15,000 from his company during the accounting year ended 31 May 2021 – the £15,000 is fully repaid in April 2021.

As the loan has been fully repaid before the company year-end there is no s455 tax charge and no disclosure needs to be made on the corporation tax return.

Example 2

Joe Bloggs borrows £15,000 from his company during the accounting year ended 31 May 2021 – at the company year end all £15,000 is still owed, however the loan is fully repaid by 31 August 2021.

As the loan has been fully repaid within 9 months of the year end there is no s455 tax charge – however a disclosure will need to be made on the corporation tax return detailing the loan balance at year-end and how much of the loan is then repaid within 9 months.

Example 3

Joe Bloggs borrows £15,000 from his company during the accounting year ended 31 May 2021 – at the company year-end £10,000 of this loan is still outstanding, and 9 months after £10,000 is still outstanding.

The s455 tax charge will total £3,250 (based on 20-21 tax rates, £10,000 x 32.5%) and is due to be paid by the company to HMRC along with it’s normal corporation tax.

The company can apply to HMRC to have the s455 tax refunded to them once the loan has been fully repaid but they can’t apply for this until 9 months after the year end in which the loan is repaid.

 

Director loan interest & benefit-in-kind

If the total loans to a director are in excess of £10,000, interest needs to be charged on the loan at the current HMRC beneficial loan interest rate or it will cause a benefit in kind disclosure and charge.

If the total loans to a director are £10,000 or less there is an exemption from HMRC that means no interest needs to be charged.

The current beneficial loan interest rate for the 23-24 tax year is 2.25% – this changes over time so you should check the current rate before calculating any interest due on a director’s loan.

When it comes to calculating the interest charge on the loan there are two different methods you can choose – the normal averaging method or the alternative precise method.

• Normal averaging method – the average amount of the loan calculated by reference to its maximum opening and closing balances at the beginning and end of the tax year. If the loan was not in existence throughout the entire year, the average is based on the maximum balances on the dates the loan was made or discharged

• Alternative precise method – this is more complex, but it does give an exact result – to use this method, for each day in the tax year that there is a loan balance the maximum balance for that day should be multiplied by the official interest rate for that day divided by 365

If the loan balance fluctuates a fair bit during the tax year, then the precise method should be used as the averaging method would give an unfair interest figure.

If interest is not charged on the director’s loan or if it is charged at a rate lower than the official beneficial loan interest rate then this causes a benefit in kind issue – the company would need to file an annual P11d benefit in kind form and it will result in some national insurance payable by the company and income tax payable by the director.

It is usually much simpler to calculate the interest, pay it and avoid the need for the P11d.

 

Summary of director loans

Borrowing money from your company can, in the right circumstances, be an efficient way of getting a loan, especially in the short term if you are certain you will find yourself in a position to repay the loan either via dividends or cash.

However, director loans also have potential issues – they can require increased disclosure to HMRC, and unforeseen circumstances can mean directors are unable to repay a loan in the planned timescale which can be very costly.

In most circumstances we recommend that director loans are fully repaid by the company year-end to avoid the s455 tax issues.

If you decide you do want to take out a director’s loan you should ensure you fully understand the tax and timing issues and ideally consult an accountant to discuss your specific circumstances before deciding if a director loan is right for you.

 

Disclaimer