Starting a business doesn’t come without its initial expenses, and an effective way to gain funding for things like stationery, rent, website packages and other start-up fees is to loan your business some money in the form of a director’s loan. This loan will help you cover the many expenses that you’ll experience in the beginning stages of starting your business before you start making a steady income and gain your first clients.
There are also instances in which you may want to borrow money from your business for your own personal use. As a limited company director, you have the opportunity to lend or borrow money from your company as you wish. For both of these, lending and borrowing, you’ll need to create a director’s loan account in order to keep track of these transactions in an orderly fashion, as you’ll need it when it comes to dealing with tax at the end of the year.
In this article, we’ll have a look at the ins and outs of director’s loans and what you need to do when it comes to taking out and giving director’s loans, as well as what you’ll need to do when it comes to writing off these loans in credit if you need to.
What is a director’s loan?
Before we start getting into the nitty-gritty, we should define a director’s loan. A director’s loan can basically be described as a monetary amount taken by the director from a limited company under their direction that cannot be described as their salary, dividend, or expenses. It is a loan taken from your company that you will have to repay at some point. Once you have taken this loan, you can use the money for whatever personal reasons you wish.
Another form of a director’s loan would be the case in which the director of a company lends their own money to the company for whichever reason that they may have. The company may have incurred some unexpected costs or is starting a new branch or business venture and needs additional funding. In most cases, director’s loans are given during the start-up phases of the company to help get things started.
There is definitely a time and a place for each of these different types of director’s loans, and you should consider the benefits and advantages available to you when deciding whether to make use of director’s loans and when.
When should I borrow money from my limited company?
If you want access to more money from your limited company than you’re currently getting through your salary or dividends, you may want to look at taking out a director’s loan. But this decision should not be taken lightly as there is a lot of admin involved with director’s loans as well as a fair amount of risk. The main risk is the heavy tax penalties associated with director’s loans. However, taking a director’s loan from your limited company can be a good way to cover unexpected bills and personal expenses, but it should by no means become a habit as it could end up costing you more than helping you.
In most cases (except when writing off director’s loans), you’ll need to pay the loan back, so keep that in mind if you simply want to take out the loan in order to do some more shopping. Most directors take out director’s loans when they’ve run into some unexpected expenses, or want to make additional investments in other businesses that they plan to make returns on. But at the end of the day, there are no rules about what you can and can’t spend your loan on.
Your director’s loan account
If you plan on partaking in director’s loans, you’ll need to create a directory, and you can use a traditional method of a book or use an application or online tool. It’s important to be meticulous when recording the director’s loans. Any cash withdrawals for personal reasons must be recorded as well as any of your personal funds that you put into the company. You can take responsibility for this yourself, or you can have your accountant or admin assistant handle this for you. Ensure that you communicate effectively with them if you’re not the one handling the account.
So long as your director’s loan account is in credit (i.e. the company owes you money), you won’t need to worry about paying any taxes on these amounts. But should the account go into a debit state, you may find yourself with tax penalties as well as concerned shareholders. You should aim to keep your director’s loan account in credit or as close to zero as possible if you want to avoid any potential issues.
How much can legally be borrowed as a director’s loan?
There is no legal limit to the amount that you can borrow from your company in the form of a director’s loan. But you should take into consideration the amount that your company will be able to afford to pay you. If you take too large an amount from your company, your business may not be able to recover from it, and you’ll have to put more money back into or close up shop. So be very careful when taking our director’s loans, and perhaps talk to your financial advisor should you want to take out a large amount.
Company directors should also note that any loan taken from the business that is over £10,000 will be seen as a ‘benefit in kind’ and will need to be reported in your self-assessment tax return. You’ll also need to pay tax on this loan, as well as interest. So keep in mind that the larger the amount, the larger the risk.
Is there a time limit in which I need to repay director’s loans?
All director’s loans must be repaid within 9 months of the company’s year-end. If you do not respect these regulations, you may be met with heavy taxes by the HMRC. Any unpaid loans may fall subject to a corporation tax of 32.5%! While you are able to claim this back once the loan has been fully paid off, it can be a very time-consuming process, and some directors don’t ever manage to reclaim this hefty tax penalty for not repaying their loan on time.
How long do I have to wait between paying back a director’s loan and then taking out another one
Once you have paid back a director’s loan back into your company’s funds, you need to wait at least 30 days before taking out a new one.
There are certain rules that apply for cases in which business owners try to evade taxes by means of ‘bed and breakfasting’.
What is ‘Bed and Breakfasting?
There are laws that are put in place to stop business owners and directors from avoiding paying the business tax that they are meant to. This process of avoidance is known as bed and breakfasting and is done by repaying their loans before year-end and then taking the loan out again immediately after. In these cases, the directors have no intention of ever truly paying this money back, and they see this money as their own to do with what they wish. When the HMRC views the director taking out large loans with no intention of paying them back, these loans will be taxed, and an investigation may take place.
‘Bed and breakfasting’ rules can be complicated, and it is best that you speak to your financial advisor should you need guidance when it comes to a continuous cycle of taking out and repaying large amounts of money from your business.
What happens if I can’t pay back my director’s loan?
If you can’t pay back your director’s loan before year-end, you will be taxed a corporation tax of 32.5%, which may be able to be reclaimed once you are in a financial position to repay your tax.
But if you’re in a position in which you don’t think you’ll be able to pay back this loan any time soon, you may want to look into writing off your director’s loan.
Writing off director’s loans
Is paying back the loan not a feasible option for you” Even if it is, many companies still opt to write off director’s loans instead of paying them back.
If your company writes off a director’s loan, there are many implications that need to be considered. That being said, it is fairly simple to write off a director’s loan so long as you stick to the procedure required from you and take the necessary advice from your financial advisor and/or accountant.
The loan needs to be formally waived if liability is to be dropped completely. The company cannot simply decide to let the remaining balance slide. It must be done properly so that the director that took out the loan will no longer be held liable for the loan, and they are no longer expected to pay back the money.
The written-off loan will be treated as dividends under the Income Tax Act 2005 and will be written off as dividends in the next tax submission. Because the loan is now treated as dividends, the company needn’t have available profits when dispensing this amount. Basically, you can get dividend treatment without being a true dividend.
The way the write-off is usually recorded is by putting it as a debit in profit and loss of the services account, but it can be done differently depending on the set-up of your accounts. However, it does need to be properly recorded.
What you may find in many cases of a director’s loan being written off is that the HMRC may say that director’s loan write-offs fall under the description of ‘emoluments from an office or employment’. And in these cases, the HMRC will attempt to collect NIC from the company and ask that the amount of the written-off loan be included in the self-assessment when the director does their tax return and have income tax paid on this amount. There is a special place to mark this in the ‘additional information’ section when doing your self-assessment online.
The amount is treated as a dividend for working out income tax, and the company won’t be able to make use of any corporation tax relief on the written-off loan. While writing off a loan may be expensive, it is often preferable to paying the loan back when the money has already been spent or if the company simply does not need the money.
What Happens to Director’s Loans When a Company Becomes Insolvent?
Companies that are liquidated or have become insolvent may have to answer for director’s loans that have not been repaid, and legal action may be taken against them as they could even be blamed for the bankruptcy. That is why it would be better to have loans written off than have numerous outstanding loans.
When your director’s loan account is in credit
When your director’s loan account is in credit, it technically means that your business owes you money, and you can make withdrawals until the balance is zero without any risk of being taxed on these amounts. It is very important to keep track of every transaction, though and don’t take out any amount without recording it.
Writing off a director’s loan is not the ideal choice for every company. If you are in a sticky situation with regards to director’s loans, you may want to speak to a professional financial advisor to help come up with the best way to deal with your director’s loan. One of the most important things to remember is that if you are a director of a company, you should never view the company’s money as your own personal funds, and you should try to keep your business and personal finances as separate as possible.