Money lent to the company
Often when a business is being set up money will be needed to fund any initial outlays that may be incurred. Loans can be made to a company by the director (usually also the shareholder in a one person business) without any tax consequences. The money is simply paid into the business bank account and repaid back as or when funds are available. Interest can be charged on money lent to the company and maybe tax free if it is less than the savings allowance. Any interest paid must follow rules set out by HMRC called the CT61 procedure. The rules can be found on the HMRC web site.
Money borrowed from the company
Although not illegal, when money is withdrawn from the business by a director as a loan, rather than as a salary or dividend, then there are formalities and rules which must be applied and adhered to.
Loans to and from a Director apply only to a Limited Company and not to sole traders.
Formalise the arrangement
Firstly, money withdrawn in this way needs to be recorded in the accounts and described as a loan. There should be a loan agreement between the company and the director to support the transaction.
If the loan exceeds £10,000 then interest at least at the prevailing HMRC rate for beneficial loans needs to be applied or a Benefit in Kind (a perk) will arise. This will result in an additional tax liability for the director to be declared both on an annual P11D return from the company, sent to HMRC, and on the Director’s self assessment tax return. The company may also need to pay Employers National Insurance (NI) on the benefit in kind.
Additional Corporation Tax
No matter how large the loan value, if it is not repaid within 9 months of the end of the company’s accounting period (its year end) then additional corporation tax will be due on the loan equivalent to the higher rate of dividend tax. This is known as s455 tax (section 455), named after the section of the tax laws that it comes from. The additional corporation tax is paid at the same time as the usual corporation tax liability for a company being 9 months and one day after the end of the accounting period. HMRC will not distinguish between tax for the year and the loan tax and will expect the whole amount to be paid on the due date.
When the loan is repaid a refund of the s455 tax can be claimed although it should be noted that this cannot be claimed until nine months and one day after the end of the accounting period in which the loan was repaid.
Repayment of the loan
Like any loan, the amount borrowed from a company by a Director should be repaid although there is often no date by which this needs to be done. As well as putting the money back into the company, repayment of the loan can be achieved by way of declaring dividends (which will need to be recorded on the Director’s self assessment tax return) and offsetting the dividend payment with the balance due on the loan or doing the same with any salary taken through the company’s PAYE scheme.
If no repayment date is set as part of the loan agreement between the company and the director then the loan can remain as a debtor to the business.
Other creditors
Where there is such a debtor and the company also owes money to other creditors (e.g. HMRC, a bank for a loan including a Covid Bounce Back Loan or others) if the loans cannot be repaid due to insufficient funds in the business then these creditors can seek repayment of the Director’s Loan. This would put those funds back into the business so that the amounts owing to creditors can be settled. This is something that may be handled via an insolvency process if the company was unable to settle its debts. In this situation an Insolvency Practitioner would be appointed who would be tasked with collecting any amounts owed to the company so that the creditors could be paid.
This can be like removing the veil of incorporation (taking away the limited liability protection for the company) with the director being ultimately responsible for the debts up to the amount that they owe the company.
This is certainly something to bear in mind noting specifically that a company which owes money cannot simply be closed down.
Get an accountant
Where there is a loan to a director in a business, because of potential benefits in kind and the additional s455 corporation tax calculation, this is usually an area where it is beneficial to appoint an accountant to provide relevant advice and to make sure the formalities are adhered to.
Doing things the right way
All too often a director gets themself in a muddle as they do not apply the necessary formalities as they withdraw money from a business leaving them with a director’s loan account when in fact the money withdrawn could be for a salary, dividends or the reimbursement of out of pocket expenses.
To avoid the business and personal finances becoming a muddle the rules set out in the “How to pay yourself” chapter should be followed. As a general rule of thumb, unless there is the formality of a loan agreement, Loans to Directors should be avoided with amounts extracted from the company by way of salary, legal (not illegal) dividends or reimbursement of out of pocket expenses.