If you own your own limited company, you might be wondering whether you can borrow money from your business. One way to do this is through a director’s loan. A director’s loan is a term used to describe money being taken out of the business that isn’t a salary, expense claim or dividend payment. But how do director’s loans work and who can use them?
In this article, we’ll explore director’s loans in more detail, including what they can be used for and whether they need to be paid back.
What is a director’s loan?
A director’s loan is a way of borrowing money from your business. In most cases, a director’s loan will have been authorised by an ordinary resolution at a board meeting which sets out the amount of money being borrowed and pays back on what terms. In some scenarios, this is done as part of a wider set of financial controls.
Director’s loans are strictly regulated. This means that you should only borrow money in this way when it is absolutely necessary, and it should only be a short term arrangement. In recent years, HMRC have been tightening their regulations on director’s loans and making greater demands on the information they receive.
When can you take out a director’s loan?
Director’s loans are often seen as an attractive option due to the flexibility that they offer and how quickly you can gain the money. However, it’s important that you fully understand what you’re taking on when you decide to take out a director’s loan, as this type of borrowing can attract high levels of taxes if the borrowing does not comply with HMRC’s strict rules.
It’s essential that director’s loans are only seen as a last resort option, and only used for short term borrowing. Whilst there are no set rules in place regarding what the borrowing can be used for, you do need to be confident that you can repay the money in time to meet HMRC’s regulations to avoid any potential financial penalties.
Examples of where a director’s loan may be used include urgent and unexpected repairs to your home, urgent repairs to your vehicle or other unforeseen personal expenses that cannot wait until you can raise the funds alone.
Can you borrow money from your business?
If you’ve been hit with unexpected and urgent bills that need to be paid, for example for an emergency repair of your property, you might be wondering whether it is possible to borrow money from your business on a short term basis.
This is where director’s loans are useful, as they provide a way for business owners to quickly borrow money for emergency situations. However, it’s important to note that this money will need to be paid back quickly to avoid financial penalty from HMRC, so it should only be used for short term borrowing.
How much can you borrow with a director’s loan?
There is no set amount that it is possible to borrow through a director’s loan. This means that there is no set limit – but it is important that you consider how much money the company can afford to lend you, and how long the business is able to cope without the money. After all, the last thing you want is for your business to suffer cash flow problems as a result of lending the money.
However, there are some rules when it comes to taxes. If your director’s loan exceeds £10,000, it will be classed as a benefit in kind. This means that you’ll need to submit a P11D form to HMRC by 6th July, as well as declaring it on your self-assessment tax return. The company will need to pay Class 1 National Insurance and you may be required to pay tax on the loan.
If the loan exceeds £10,000, you will need to seek approval from all shareholders in the company. They will need to agree to the borrowing, as well as the terms that will be used, before the lending can take place.
So, whilst there is no legal limit on how much you can borrow from your company as a director’s loan, there are things that you’ll need to consider before deciding on how much to borrow.
When do you have to repay a director’s loan?
If you’re thinking of taking a director’s loan, you might be wondering how long you’ve got to pay it back. Whilst there are no set timescales for paying back a director’s loan, there is a point at which you will become liable for paying corporation tax at 32.5%, so it’s best to avoid this if possible.
To avoid being hit with corporation tax, you’ll need to repay the director’s loan within nine months and one day of the company’s year-end date. If you haven’t paid back the loan by this point, the company will be charged corporation tax at 32.5%. You might also hear this referred to as S455 tax.
If you do have to pay corporation tax on your director’s loan, you can claim this back when the loan has been fully repaid. However, this is often a lengthy process, so you could be waiting a while to get the money back.
You can claim back corporation tax on director’s loans nine months after the end of the accounting period in which the debt was cleared. If you’re able to pay back the director’s loan shortly after the company’s year-end date, one way to make this easier is to avoid paying the corporation tax until the deadline. As the corporation tax is nine months after the financial year end date, and you can also claim back your corporation tax from this date, it means you’ll only be left without the money for a short period of time.
Do you have to pay tax on a director’s loan?
Whether or not you’ll have to pay tax on your director’s loan will depend on how much you borrow and how long it takes to repay the money.
If you borrow less than £10,000 and pay the money back within nine months and one day of the company’s financial year-end date, you won’t have to pay any tax on the loan. However, if the money is not paid back within nine months and one day of the company’s year-end, the company will need to pay corporation tax at 32.5% of the outstanding balance of the loan. You might also hear this corporation tax referred to as S455 tax.
Not only will you have to pay corporation tax on any outstanding loan balance, but interest will also be charged on the corporation tax. The current rate of interest stands at 2.25% in the 2021-22 tax year. This is seen as a deterrent to prevent company owners from misusing director’s loans.
As we previously discussed, the corporation tax can be reclaimed nine months after the accounting period in which the loan was repaid. However, the interest on the S455 tax cannot be reclaimed, so it’s always best to pay off the director’s loan within nine months and one day of the company’s year-end date.