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Director’s Loans – A Handy Asset or An Accident Waiting To Happen?

In these challenging economic times, the ability to borrow money from your company is a handy resource to have at hand.  However, what happens if the borrowing becomes a more regular occurrence, and ultimately, the company director can’t repay what has been borrowed from the company? 

In this short article, we look at the pros and cons of Director’s loans, and how we advise handling them.

What Is A Director’s Loan?

A director’s loan is funds you take out from your company’s bank account that isn’t classed as salary, dividends, or legitimate expenses. In simple terms, it is money that you, as a company director, borrow from your company and will have to eventually repay.

The alternate scenario is when a director lends money to the company. This could be in a start-up situation or to help the company through cash flow difficulties. In this case, the director becomes one of the company’s creditors. 

HMRC have issued detailed guidance to follow in either scenario –

For the purpose of this article we are going to focus on the first scenario, a director borrowing funds from the company.

The Pros

The main advantage of a director’s loan is being able to borrow money easily and cheaply, especially for short periods. Directors can use a short-term loan from the company to pay an unexpected personal bill instead of taking a dividend, which may have higher rate tax implications for the director.

There is no maximum value that a director is allowed to borrow through a director’s loan but consideration should be given towards how much the company can afford to lend before the business itself will suffer from cash flow shortage.

The trick is to repay the loan to avoid any corporation tax consequences.  It also saves having to utilise external sources of finance, who will charge higher interest rates and most likely tie you in to a fixed repayment period.

The Cons

When a director takes more money out of the company than they put in they are in an overdrawn position. Remember that the loan needs to be paid back to the company.  The loan becomes problematic if your company finances change due to cash flow challenges or unforeseen financial problems arise. The director’s loan may exacerbate the cash flow situation and have a negative impact on the overall company activities – possibly even leading to forced closure.

The size of the loan is also important to consider. If you have taken out a significant director’s loan, HMRC may view the loan as salary. This is most likely to happen when your loan exceeds £10,000. If HMRC considers this to be a withdrawal for salary, you will, of course, become liable for national insurance and income tax on it.

Finally, there is a time limit on paying back a director’s loan. The director’s loan must be paid back in full to the company accounts within 9 months and one day of the company year-end. If you fail to do this in time, you will be charged a corporation tax charge, which is currently 32.5% of the loan amount. If you fail to pay back the loan altogether, you could be forced into personal bankruptcy. 

Our Final Thoughts and A Checklist For You To Follow

There’s no issue with having a director’s loan.  However, we advise our clients to only take a director’s loan in short-term scenarios.  Below is a short checklist if you are considering a director’s loan.

•             Only take out a director’s loans when it is absolutely necessary

•             Repay your director’s loan within nine months and one day of the company year-end if possible

•             Borrow less than £10,000

•             If you must borrow £10,000 or more, you must report it on your self-assessment tax return and the company must treat it as a benefit in kind

•             Wait at least 30 days between taking out different director’s loans

•             Be certain that your company has made a profit before declaring dividends

Director’s loans are a complex area and shouldn’t be used without due consideration.  Up to date accounts and good cash management are key when considering a director’s loan.

Need More Advice And Support With Director’s Loans?

Get in touch with NKY Consulting to find out how we can help with Directors Remuneration Review.  After a quick fact find, we’ll give you some simple advice on how to pay yourself in the most tax-efficient way.