What is a Director's Loan and do you need to pay tax on it?
As a director there are a few ways that you can take money out of your company, including drawing a salary (through PAYE), dividend payments, and making expense claims. However, there is another method that can be used which is taking out a director's loan.
What is a director's loan and how does it work?
A director's loan is any money which a director receives from the company which is not classed as a salary, dividend or expense repayment. It can also be any money that they have previously paid into, or loaned, the company. For example, this could be where a company has lent money to a director.
Although a director's loan is not considered in the same way as a salary or dividends, it is vital that accurate records are kept as director's loans are subject to their own tax rules. These records are commonly known as a Director's Loan Account (DLA) or a director's current account.
What should be recorded in the DLA?
There are a few key pieces of information that should be recorded in the DLA, including:
- Money borrowed from the company by the director
- Personal bills of the director that have been paid for by the company
- Any repayments of the directors loan
- Money owed by the company to the director (e.g. salaries or dividends)
The DLA is essentially a balance sheet which lists the transactions between the company and the directors. If you're using accounting software you may have multiple DLAs set up where you have more than one director.
What taxes are associated with a director's loan?
This depends on the amount borrowed and how the loan has been settled. However, it's a combination of personal tax and corporation tax that will have to be paid for the loan.
If a director borrows money from the company, and repays the entire loan within 9 months of the end of the Accounting Period, there is generally no tax to be paid on the loan. Any overdue payments will be subject to 32.5% of the outstanding balance.
It may be the case that you paid interest on the loan. If the interest has been paid at a rate below the official rate, the discounted interest will be treated as a benefit in kind and should be reported on a personal tax return. If this happens, the director may need to pay tax in respect of the difference between the official rate and the discounted rate.
Loans over £10,000
If a DLA exceeds £10,000 it will be considered a "benefit in kind" which must be reported on the director's self-assessment tax return. Tax may need to be paid on the loan at the official rate of interest. Additionally, the company will need to pay Class 1A National Insurance at a rate of 13.8% on the full amount of the loan.
"Bed and breakfasting"
If a director's loan is repaid within the 9 month period, but the director immediately take out another loan, this is known as "bed and breakfasting".
This is a common method to avoid paying tax on the loan, however, the tax rules have been tightened in recent years, to help combat this. This was done to deny the tax relief on director's loans being used in this way.
The rules around director's loans can be quite complex, so professional advice should always be sought on them.
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