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Directors loans and shareholder loans

Directors loans

Something you hear about sometimes is the concept of directors loans – or shareholders loans.

First, to clarify, this could refer to separate things. It could refer to the ongoing balance of money loaned to a company by its directors or shareholders – in essence capital in the business, or it could refer to money lent by the company to its shareholders or officers.

Money Lent to a Company

Lending money to a company is relatively uncontroversial.

This could be:

  • money expressly introduced to the company as a lump sum
  • expenses incurred for the company and not reclaimed
  • assets introduced to a company
  • undrawn salary and dividend

There are no legal restrictions on lending money to a company, and no adverse tax issues for the company or the director / shareholder.

A couple of points to watch though:

  • charging interest for money lent to a company ~ this can be done, but there are tax complications to do with deducting tax at source. Best avoided unless necessary. Any interest is normally tax neutral in terms of being an allowable expense for the company and chargeable to tax for the lender.
  • if you lend money to a company it can end up being pooled with a general balance of directors current account, and set off against other transactions with the directors or shareholders – its quite possible to lose sight of the balance or indeed to find a loan being eroded over years. It is sometimes necessary to keep a loan expressly separate for this reason.

Borrowing From Your Company

Tax on directors loans

Tax on directors loans

Borrowing money from a company is often suggested as an alternative to taking salary or dividend, the attraction being the avoidance of personal tax. Alas it’s not that simple.

First, legality – until the enactment of Companies Act 2006 loans to directors or shareholders were generally illegal – although the only party interested in enforcing that was generally the shareholders themselves. That has now changed, and loans to directors or shareholders is now legal, although loans over £10,000 should be approved by the shareholders – normally one and the same of course.

In terms of tax, a special charge exists under s 455 CTA 2010, sometimes known as Advance Corporation Tax. This dictates that if a loan is made to a director or shareholder then a tax payment equal to 25% of the loan value needs to be paid to HMRC if the loan is still outstanding 9 months after the year end – this tax is repaid to the company 9 months after the accounting year in which the loan is repaid.

It’s worth noting that for a Higher Rate tax payer this 25% is the same as the Higher Rate tax they would pay personally on excess dividends, thus neutralising any advantage from a long term loan.

For example, assume a company has a 31 March 2015 year end:

(a) a loan of £10,000 is made to a shareholder on 1 June 2014, and repaid 1 March 2015. As it’s not outstanding at the year end, no s455 tax is due.

(b) a loan of £10,000 is made to a shareholder on 1 June 2014, repaid 1 March 2016 – as this is outstanding 9 months after the year end, s455 tax of £2,500 is due on 1 January 2015 (along with the Company’s normal Corporation Tax payment). This tax is, all other things being equal, repayable 1 January 2016, 9 months after the end of the financial year of release.

(c) a dividend of £10,000 instead of the loan would incur no extra tax for a Basic Rate taxpayer and £2,500 for a Higher Rate tax payer.

It should be noted that HMRC are wise to “recycling” of lending, e.g. repaying a loan a few days before the financial year end and re-lending it within a month later.

Generally the effect of the above is that a short term loan causes no tax issue, but if the lending goes on beyond 9 months after the financial year end, or is recycled, then the s455 tax cost matches the tax costs of a dividend.

A further complication relates to loans over £5,000 where a personal Benefit in Kind (BIK) charge for Income Tax and NI applies on notional interest unless interest is charged by the company and physically paid to the company by the director or shareholder. The “official rate” of interest which is used to both work out the BIK, and as a benchmark for exemption if interest is charged and paid, can be viewed at:

http://www.hmrc.gov.uk/rates/interest-beneficial.htm

The BIK applies separately from the s455 liability and the provisions re 9 months after financial year end, etc,

Generally the effect of the BIK is to make many loans uneconomic and to prefer dividends instead.

Finally, it should be borne in mind that a so called “overdrawn” directors account – where money has been drawn from a company in excess of the salary or dividend or expenses available – counts as borrowing and the above regime applies. It is important to make sure that monies taken from a company, in particular interim dividends, are covered by distributable profit available.

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