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Demystifying the Director’s Loan

By Anita Jaynes on 29 September, 2021

Post sponsored by Purple Lime

If you run a business, you have probably thought about the best way to take money out of your business more than once. And once you look into it, you might have realised that there are a number of ways to do it, all depending on the outcome you want. One of the methods you might have considered is a director’s loan. In fact, your accountant may have told you that you should already be taking money out as a director’s loan repayment, even if you weren’t before. And there is a good reason for that, but first you need to understand what a director’s loan is.

What Is A Director’s Loan?

In essence, a director’s loan can be two things. The first is when you, or other close family members, get money out of your company that is not a salary, dividend, or any other legitimate expense repayment. It’s money that your company is loaning to you, that you will eventually have to repay. The second is when a director lends money to the company from their own pocket – this one is very common for start-ups needing to get set up when they do not actually have an income yet. By doing this, the director becomes one of the company’s creditors, and can withdraw that money as a loan repayment in the future when the company is profitable, rather than as a dividend. So if you poured money into the company in the beginning and it is now profitable, you could take that money out as a director’s loan repayment, without having to take a dividend.

What is a Director’s Loan Account?

When you take out a director’s loan, you will need to create a director’s loan account (or DLA). This is where you keep track of all the money you either lend the business or borrow from it. It is also where you keep track of all your director’s loan repayments. Running it is pretty simple – if the company is borrowing more from its directors than it is lending, then the account is in credit. But if the directors are borrowing more, then the DLA is overdrawn. If the account is overdrawn for a long period of time, then this can be a concern for stakeholders and shareholders, so it is important that your DLA is well managed. A good accountant can help you with this.

So How Much Can I Borrow?

When it comes to a director’s loan, there is no legal limit to how much you can borrow. But there are some things to consider that may put an informal limit on how much you decide to take out. For starters, understanding how much the company can afford to lend you without ending up in financial trouble is key – you do not want to spend more than your company has in the bank, or keep the money out of the business for too long. Another risk is tax. You can take a director’s loan of up to £10,000 without issue, but anything above that is classified as a ‘benefit in kind’. This means it must be reported on your self-assessment tax return, and you may have to pay tax on the loan as well. This is one of the reasons we recommend seeking full shareholder approval before taking a director’s loan of above £10,000. If a director has taken out a director’s loan, they can take out another, provided the first one has been repaid for at least 30 days.

What About Tax, Interest and Other Extras?

Of course, as with all money matters, there are things like tax and interest to take into account. In terms of interest, it is up to your company how much it charges for a director’s loan. But as best practice we recommend using the Bank of England base rate as a minimum – since anything lower than that can also be considered a ‘benefit in kind’ and lead to more tax on the difference between the base rate and what is being charged. You will also need to pay Class 1 National Insurance contributions (13.8%) on the full value of the loan.

And of course, there are late repayment issues.

Repayment of Director’s Loans

HMRC states that a director’s loan must be repaid within nine months and one day of the company’s year-end. If it is not, then the company will face a pretty heavy tax penalty. Any balance left unpaid at that point will be added up, and will be subject to a 32.5% corporation tax charge. Thankfully, you are able to claim this back once the loan has been fully repaid. But most companies try to avoid this, as it can be a very lengthy and complicated process, and can cause cash flow problems while you wait.

Director’s loans are a pretty tricky area of business finance, and if they are to be done effectively than you need a skilled accountant to help you navigate the waters. At Purple Lime, we are on hand to help you understand the implications of a director’s loan for your business, and guide you through the process. If you would like to know more, please get in touch by emailing hello@purplelime.uk.com, or calling us on 01249 691360.

Visit Purple Lime online at: www.purplelime.uk.com

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