Let's talk about a director who wishes to borrow some money from his company in the form of a director's loan.
Usually with a director's loan, more often than not, provided you have enough profitability in your company, the Director would extract this as Salary or Dividends, or a combination of both of course.
What if I take Dividend because the Bank balance is high because I took out the Bounce Back Loan or something like that?
Simple to say that, in order to pay Dividend at any given time, be this Interim Dividend or Final Dividend, you have to make enough profit to do so. If you take Dividend but have not made enough trading profit, then this is called an ‘Overdrawn’ Directors Loan Account.
This often happens in a scenario whereby the money that has come in, is not from trading. Your bank balance is healthy through a Loan from a provider such as a Bank or an organisation like, Funding Circle etc.
In this case essentially a Dividend is not acceptable, and money extracted in this way, not from profits of the company, is called a Directors Loan.
Important Note about how you Extract from the Company-Taxation
Dividends are a distribution of profits
You pay 19% Company Tax on all of your Profits, so all Dividends you extract from the company have 19% tax on them.
Salary payment to the Director, on the other hand is an expense to the Company.
Such "expenses" come off the profits of the company, they reduce Profits.
As Profits are reduced so is the Company Tax
If I take Salary how does it affect my Personal Tax?
Having Salary goes on your Personal Tax Return, as Director.
As long as you are within your £12,500 personal tax threshold then you pay no Personal Tax. You may pay some National Insurance though.
Your choice is a Salary of either
£1,041.67 per month (£12,500) per year with some stamp(National Insurance) or
£791.67 per month which is £9,500 per year. No Employee National Insurance or Employer National Insurance but it could affect
the level of
State Pension later in life, or other benefits that are based on paying National Insurance such as for example, Maternity Pay, or Paternity Pay(Where it can affect the levels of those benefits).
As above, like we say, paying Salary, has the effect of reducing the corporation tax.
Scenario 1 - Director takes out £20,000 loan
None of the loan is paid back but will be paid back at some point in the future.
A Directors Loan needs to be paid back within 9 months and 1 day from the Accounting Year End.
Let’s say the year end is 31 March. That means the Director needs to pay the loan back by 1st January the following year( 12 months and 1 day after the year end)
- In this scenario none of the £20,000 is paid back
- There will be 32.5% Company Tax on the loan, so this is 32.5% x £20,000 being £6,500 of Company Tax payable on 1 st January following 31 March year prior.
- If at a later point in time the Director pays the loan back, you apply to HMRC for a refund of this amount.
- Getting the money back is not straightforward. It can be a lengthy and difficult process.
- Further to this, HMRC will add Interest to this amount until the Company tax is fully paid or the loan is repaid. Under the regulations of HMRC you cannot claim back this Interest element.
Plus the Director has to pay the Company interest on the Loan from the Company at the “official rate” of interest. If the interest paid is below the official rate , the Director has to
- Record interest paid below official rate as Company “Income”
- Treat discounted interest as “Benefit in Kind”.
- This benefit in kind favourable rate of Interest goes onto the Director’s Personal tax Return as income and may have tax on it. Depending on if the Director is a basic rate tax payer or not, some of the tax may be at either 20% tax rate or higher rate 40%.
Scenario 2 Loan “ Written off”
The loan could be “Written off” or “Released” meaning it will never be paid back by the Director to the Company.
- Here, Class 1 National Insurance is deducted through the Payroll
- The director Personally pays income tax on the loan on their Self Assessment Tax Return at basic or higher rates of tax.
Extra bits of Admin with loans over £10,000
Further, there are there are some other bits of red tape that has to be done if you have a loan that is more than £10,000.
If you are a shareholder or a director (or both) and you owe the Company more than £10,000, you have to
- treat the loan as a “Benefit in Kind” and
- report this on the yearly P11d Benefits and Expenses Declaration
- Plus deduct class 1 National Insurance
As above, the Director has to pay the Company interest on the loan at the official rate of interest.
When can my Company reclaim the Company Tax from HMRC, if I repay the Directors Loan?
If you pay the loan back to the Company in the due course of time, you have within a maximum claim period of 4 years to claim back the Company Tax paid out. After 4 years you cannot reclaim the Company tax paid out. You cannot claim the Interest element of the loan that you have paid.