Directors play a pivotal role in the operation of a company, often making important financial decisions. Occasionally, directors may find themselves in need of financial support from the company they manage.
Alternatively, the director may make a loan to the company. In both circumstances, it’s important to follow the laws relating to directors’ loans and arrange for a director’s loan agreement to be entered into.
In this guide, we’ll delve into the nuances of director's loans, providing insights into their purpose, operation, tax implications and more.
What is a director's loan?
A director's loan is a financial arrangement between a company and one of its directors. It involves the director borrowing money from the company or vice versa. These loans are commonly documented in a director's loan account, which tracks the financial transactions between the director and the company.
How does a director's loan work?
A director's loan account serves as a record of all financial transactions between the director and the company. It’s used to track:
- Any funds borrowed by the director from the company – if a director needs financial assistance, they can borrow money from the company and this amount is recorded in the director's loan account
- Funds lent by the director to the company – conversely, a director can also lend money to the company, which is recorded in the same account
- If interest is charged on the loan – if interest is charged on the loan, it should be at a commercial rate, which is a rate comparable to what a bank would charge
- Repayments made by the director – the director must repay the loan within a specified period, typically within nine months and one day after the company's accounting period ends
Are director's loans debt?
Yes, director's loans are considered as debt owed by either the director to the company or the company to the director. These loans are accounted for as financial liabilities on the company's balance sheet.
Do director's loans have to be paid back?
Yes, director's loans must be repaid. The director is obliged to repay the loan within the stipulated time frame, usually nine months and one day after the company's accounting period ends. Failure to repay may have tax implications and financial consequences.
How long can a director's loan be outstanding?
As mentioned above, a director's loan is typically repaid within nine months and one day after the company's accounting period ends to mitigate tax consequences. If the loan remains outstanding beyond this timeframe, it can lead to tax consequences for both the director and the company. We recommend taking tax advice from an accountant or tax advisor before taking out a director’s loan.
Can directors charge interest on loans to the company?
Yes, directors can charge interest on loans they provide to the company. The company and director should ensure that the interest rate is at a commercial level, similar to what a third-party lender would charge. Charging excessive interest rates can have tax implications.
How to pay back a director's loan?
Directors can repay a director's loan in several ways:
- Cash payment – the director can repay the loan in cash or by transferring funds to the company's bank account
- Offset against salary or dividends – if the director is owed salary or dividends by the company, they can choose to offset these amounts against the outstanding loan
- Declaration of a dividend – the company can declare a dividend to repay the director's loan (however, this is subject to the availability of distributable profits)
- Write off – in some cases, a director's loan may be written off, but this can have tax implications and it should be done in accordance with legal requirements
Tax and accounting advice should be taken on the above methods to avoid any unexpected tax implications for the director and company.
Does a director's loan reduce corporation tax?
No, a director's loan doesn’t reduce corporation tax. In fact, if the loan isn’t repaid within the specified timeframe, the company may incur additional tax charges, known as Section 455 tax, which is a temporary tax on outstanding director's loans.
Can a company write off a director's loan?
Yes, a company can write off a director's loan. However, it must follow the legal procedures for doing so, which typically involve passing a resolution at a board meeting. Writing off a loan can have tax implications for both the director and the company, so it should be done carefully and in compliance with tax advice.
Tax implications of director's loans
Director's loans can have significant tax implications for both the director and the company. Here are some key tax considerations:
- Income tax – if the director's loan exceeds £10,000 at any point during the tax year, they may be liable to pay income tax on the loan at the basic rate
- Benefit in kind – if the director's loan is interest-free or has a low interest rate, it may be considered a benefit in kind, subject to taxation
- Corporation tax – as mentioned above, if the director's loan isn’t repaid within the specified timeframe, the company may be subject to Section 455 tax, which is payable at a high rate
Tax and accounting advice should be taken regarding the implications to avoid any unexpected tax for the director and company.
Get legal assistance from LawBite
Director's loans commonly take place and often provide necessary financial support for directors and the company itself. However, it's important to understand the legal and tax implications associated with director's loans and ensure compliance with English laws and regulations.
Our team of experienced corporate and commercial lawyers can assist you in:
- Drafting director's loan documentation – we can create comprehensive and legally sound Director's Loan Agreements tailored to your company’s requirements, ensuring that all necessary legal provisions are in place to protect your company’s interests
- Reviewing existing arrangements – if you already have a Director's Loan Agreement in place and want to ensure it complies with current legal requirements or understands its terms, our lawyers can provide a review of the agreement and its terms
- Providing legal advice – we can guide you through the legal complexities of director's loans, helping you make informed decisions that protect your business and financial interests
- Tax and accounting - we can refer you to tax and accounting advisors to help you assess the tax consequences of making director’s loans