What Is A Director’s Loan & How Do They Work?

Running a business requires more than just dedication—it demands financial flexibility. 

But what happens when you need quick cash for your business? For many, director’s loans provide a convenient solution, allowing them to borrow from or lend to their limited company. 

According to a report from HM Revenue and Customs (HMRC), around 25% of small business directors in the UK have used a director’s loan at some point to support cash flow. 

However, navigating the rules around these loans can be tricky, and non-compliance risks are significant.

This guide covers all you need to know about director’s loans, from definitions and compliance to best practices for managing them effectively.

What is a Director’s Loan and How Does it Work?

A Director’s Loan refers to any money a director lends or borrows from a limited company that doesn’t fall into the categories of dividends, salary, or expenses. 

Directors of limited companies may use company funds for personal purposes, but any transactions must be recorded in a Director’s Loan Account (DLA). This account tracks amounts borrowed or loaned back from or to the company to comply with tax regulations and ensure compliance.

An unexpected director’s loan could leave the company or director with debt to HMRC at the end of each financial year, with specific tax implications arising if one owes money back. HMRC closely oversees these transactions, and any tax implications may become evident if one or both owe money back.

Here’s an example:

1. You withdraw £1,000 from the business account.
2. At the end of the month, you run payroll and pay yourself a salary of £500. 
3. At the end of the year, you declare £15,000 in dividends, assuming the company has enough funds.

• Your loan account will now show £14,500 in credit (companies owe you) because the £500 salary and £ 15,000 dividends were paid to you. But you have already £1,000, so you have £14,500 net. 

NOTE: The dividends you declare and the money you withdraw from the company sometimes match. HRMC tracks the money you withdraw through the director’s loan account, which is offset against future dividends or salary payments.

In Credit Director’s Loan

The In Credit Director’s Loan is simpler than its counterpart. In Credit is when you lend your company some quick cash. HMRC does not impose taxes unless the director imposes one.

However, when a director can choose to charge interest on the Money that he lends, there are some tax implications: 

• This interest will be considered income for the director. 
• The Company will have to submit CT61 to declare interest (to claim allowable expense under company profits and loss accounts.) 

Overdrawn/Debit  Director’s Laon

In case you take a loan from a company.

As a director, you borrow money from your company and must repay it within a specific time per HMRC guidelines. 

Below are actions a director should take when taking money from the company:

1. Shareholders must approve a director’s loan. (An exception is if you are operating as a sole trader; then a written approval document should work.)
2. Make sure your loan is adequately established. Specifically, an active loan agreement must govern its terms before filing annual income taxes with HMRC.
3. The loan agreement should include information such as:

• Identity of both parties (the company and director) 
• Any essential terms and conditions of the loan (such as amount, repayment details, and interest payable – which will form part of the assessable income of the company) 
• Signature and date

What are the tax implications on the Overdrawn/Debit Director’s Loan?

If you return your loan taken from the company within 9 months from the loan date, there will be no tax implications.

However, after 9 months, you must pay a tax known as the S455 charge, which is 33.75% (Subject to change as per HMRC ) of the loan amount. This implication is to prevent using a director’s loan as a tax-avoiding tool.  

Moreover, you only have to pay S455 on advanced loans, not the whole loan balance. For example, if the balance on the loan is raised from £8,000 to £10,000 in one year, you only pay 33.75% on the added £2,000. 

You must submit a supplementary tax page, CT600A, to declare. The tax will be calculated as a percentage you pay with corporation tax. 

However, this 33.75% tax you pay is also refundable when you repay the company’s loan.

How you can reclaim Tax paid on Overdrawn DLA 

Reclaiming Within 2 Years

If you are reclaiming within 2 years of the end of the accounting period when the loan was taken, use form CT600A to claim when preparing or amending your Company Tax Return online.

If either of the following applies, use form L2P instead:

• Your tax return covers an accounting period different from the date of the loan you take.
• You are amending your return by post.

Make sure to specify how you would like the repayment in your Company Tax Return.

Reclaiming After 2 Years

If you are reclaiming more than 2 years after the end of the accounting period when the loan was taken, complete the L2P form and submit it with your latest company tax return or send it separately by post.

HMRC will process the repayment by either:

• Using the details provided in your latest Company Tax Return, or
• Sending a cheque to your company’s registered address.

How much can you withdraw from the Director’s Loan Account?

There is no legal limit on how much directors may withdraw from their director’s loan account; however, if the loan amount exceeds £10,000, your DLA could incur tax consequences. Below are the implications that can occur. 

Benefit in Kind Tax

If the loan goes overdrawn by £10,000, this could trigger a benefit-in-kind tax, which can incur tax as though you attach interest.

• HMRC treats interest-free loans as “beneficial” and will consider them a benefit in kind. HMRC will add tax as per the BIK Rules.

Exceptions apply under Benefit in Kind Tax:

• If a company charges interest on loans while complying with HMRC guidelines, benefit-in-kind tax may not apply to them. 
• When loans never surpass £10,000 during any one tax year, tax on beneficial loans generally doesn’t kick in either.

How to Report Benefits in Kind Tax

• Provide details of benefits in kind (including overdrawn loans) using Form P11D.
• Submit Form P11D(b) by July 6 annually to HMRC to show its Class 1A National Insurance liability.
• If your company’s financial year-end doesn’t coincide with tax year-end, prepare your books to be accurate for P11D reporting at the end of the tax year. 

What happens if you Report a Late Tax

• HMRC charges an administration fee of £100 for every 50 employees monthly (or part month) when the P11D(b) returns are late.
• Additional penalties and interest that could accrue for delayed payments to HMRC.

Though there’s no limit on how much you can withdraw, be mindful of any tax obligations and deadlines that might apply in case of an overdrawn loan account.

Best Practices for Managing Director’s Loans

1. Under any circumstance, consider the director’s loans when necessary (i.e., after investigating all other possible solutions first). 
2. You should aim to repay any director’s loans within 9 months and 1 Day of your company’s year-end. 
3. Try not to borrow more than £10,000 at once.
4. If you borrow over £10,000 in loans for personal use, you and the company must report this activity on their tax returns as benefits. 
5. We recommend waiting at least 3 months before taking out another loan of this size. However, as per the HMRC rule book, you can take out a loan after 30 days, but it is challenging to satisfy HMRC that you are not doing it for tax evasion purposes. 
6. Ensure both should use appropriate tax treatment when loaning money back out.
7. Never allow your Director Loan Account (DLA) to remain overdrawn for extended periods.
8. Always be sure your company has made a profit before declaring dividends. 

As director loans are complex financial tools, one should take their use seriously and regularly. 

Whether you are borrowing or lending from your company, it is imperative to comprehend the implications of interest rates, taxes, and repayment dates. Also, regular monitoring and accurate accounting are necessary to avoid complications with HMRC and ensure regulatory compliance.

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