Used wisely, a loan from your company can be a helpful way for a director to access funds. It can be useful when cash is needed quickly. However, there are important director’s loan risks. Tax rules are strict, and poor planning can create unwelcome bills for both the director and the company.
Below is an overview of the main risks to think about before you draw money out of the business in this way.
Personal tax implications
Most directors know that taking a loan from the company can affect their personal tax position. This happens when the loan counts as a “beneficial loan” for tax purposes.
A beneficial loan charge arises where:
- The interest on the loan is less than HMRC’s official rate of interest (currently 3.75%), and
- The director’s total beneficial loans from the company exceed £10,000 at any point in the same tax year.
In that case, HMRC treats the director as receiving a taxable benefit in kind. HMRC calculates the value by looking at the interest actually paid and comparing it to interest at the official rate.
In practice, the resulting tax bill is often modest. For example, say you take an interest-free loan of around £20,000 for six months. If you pay higher rate tax, the personal tax cost is roughly £150. Even so, you should factor this in when you plan so there are no surprises at year end.
Company tax implications
The position on the company side is more complex. This is especially true where the director is also a shareholder and the company is a “close company”. Most owner-managed businesses fall into this category.
The key points are:
- There is no extra company tax charge if the loan is fully repaid by the time the company’s corporation tax is due. That date is nine months and one day after the end of the company’s accounting period.
- If the loan is not repaid by that deadline, the company pays an extra tax charge at 33.75% on the part of the loan still outstanding. This is on top of corporation tax already due.
- The company can reclaim this 33.75% charge, but only after the director has repaid the loan.
Because of this, director’s loans that are allowed to run on, or that grow to larger amounts, can become expensive. They can also be difficult to unwind. What might start as a short-term cashflow solution can soon turn into a significant funding and tax issue.
As a result, these company charges form a major part of overall director’s loan risks, particularly when cashflow is already tight.
Wider risks and red flags
The tax charges are not the only concern. A director’s loan that is not repaid on time stays on the company’s balance sheet as money owed by the director. If the balance is large, or has been outstanding for some time, it can raise questions for anyone reviewing the accounts.
In particular, a sizeable director’s loan can:
- Act as a red flag for banks and other lenders when the business needs finance
- Put off potential investors who are checking how prudently the company is run
- Undermine confidence among key customers or suppliers who review filed accounts as part of their due diligence
For these reasons, director’s loans should be used sparingly. It is important to have a clear plan for repayment and a full understanding of both the tax and commercial implications.
HMRC provides detailed guidance on the rules around director’s loans. The guidance includes examples and definitions of close companies. You can use it to check how the rules apply in your situation and what HMRC expects in practice.