Why would your limited company require a Director’s loan?
- You’re starting a new business, possibly with other directors, and you want to provide initial funding for the company.
- Your limited company is currently making a loss, and you want to inject some working capital into it.
- You want to buy some equipment or another type of asset via the company, and there aren’t currently sufficient funds to pay for the asset but will be in the future.
- A landlord may lend money to a property company to help with capital acquisition
- During the Incorporation process when passing property from partnership ownership to company ownership
Check legal aspects first
The first step is to make sure the company’s Articles of Association allow the company to borrow money from directors, and double check whether the Articles impose any special terms or restrictions on these loans.
Whatever your reason for borrowing, we recommend you create a loan agreement between the director(s) and the limited company – which are distinct legal entities. The agreement should detail the loan size, interest rate, term, and any other conditions. There is no obligation to do this, but it creates a paper trail which may prove useful in the future particularly in the event of a dispute or death of the director.
What is the director’s loan account?
The director’s loan account (DLA) is where you keep track of all the money you either borrow from your company, or lend to it. If the company is borrowing more money from its director(s) than it is lending to it, then the account is in credit. However, if the director(s) borrow more, then the DLA is said to be overdrawn.
Director’s loan interest rate
You are able to charge the company interest on any money you have paid from personal funds that has yet to be repaid (your director’s loan account).
The rate of interest charged must be deemed to be a commercial or market rate. The rate needs to be reasonable and we typical recommend 3.25% being a reasonable rate. If you are making a loan to a company which you do not own shares in then this would be a much higher rate in line with what third party lenders would charge for an unsecured loan – probably in the region of 10%.
How are the interest payments treated for tax purposes?
When paying the interest to the director, the company must deduct basic rate tax at 20% and pay this to HMRC, together with completing a CT61 form (brief details are outlined at https://www.gov.uk/directors-loans/you-lend-your-company-money).
Interest paid by the company is a tax-deductible expense, consequently reducing the company’s Corporation Tax bill too.
The interest received is then declared on the Director’s Self-Assessment tax return, but the interest could be tax free if covered by the Personal Savings Allowance.
The Personal Savings Allowance is as follows:
Basic rate £1,000
Higher rate £500
Additional rate £0
The interest can be paid net to the Director(s) or credited to the Director’s Loan Account which is then available to the Director(s) to withdraw as an alternative to salary and dividends.
An Example of how this might work
A Director is paid net interest of £4,000 on their Director’s Loan Account on 31 March 2021. This would be gross interest of £5,000 less £1,000 for the 20% tax. The Company would need to register with HM Revenue & Customs and file a CT61 with a tax payment of £1,000 by 14 April 2021.
On the Director’s Personal Tax Return, they would record the following:
- Interest Received (gross) £5,000
- Less Personal Allowance £1,000
- Taxable Interest £4,000
- Tax due at 20% £800
- Tax deducted at source (£1,000)
- Tax refund due (£200)
In the Company Accounts the following entries would be made:
- Director’s Loan Account would be credited by the net interest amount of £4,000 (£5,000 less £1,000).
- Interest would be charged in the Profit and Loss Account of £5,000 and so the Company would be able to get tax relief at the current Corporation Tax rate which is currently 19% so the Company would make a tax saving of £950.
The net tax cost overall is:
Company pays CT61 tax £1,000
Company saves corporation tax (£950)
Director receives tax refund (£200)
Overall Tax saving £150
In addition, an amount of £4,000 has been withdrawn efficiently or is available to withdraw from the Company.
Things to consider when lending cash to your company
If you make a director’s loan to your company, the amount will be included on the company’s balance sheet (as a creditor).
Your company can repay a loan at any time, should the directors decide. The amount showing as a creditor on the balance sheet will be reduced until it is fully paid.
If you want the company to repay (or part repay) a loan at any time, make sure there are sufficient funds in the company to meet its ongoing liabilities, such as tax.
When considering any aspect of lending money to your company – and how you conduct transactions related to loans, don’t forget that limited company directors are obliged to always act in the best interests of the company.
Further advice on director’s loans
If you require further advice on using director loans efficiently please get in touch with us via our contact form.