A director’s loan is made up of any money that you take out of your company that is not wages or dividends.
Wages and dividends
It’s easier to understand director’s loans when you separate them out from the other ways that a director can take money out of their company.
The first and most familiar way to get money is through a wage that is registered on your HMRC payroll. However, most directors don’t pay themselves a particularly high wage, as this allows them to stay below the National Insurance Primary Threshold of £10,600 per year.
The rest of the director’s earnings are normally made up of dividends, which are sums of money given out by the company at the end of the year after tax.
Paying yourself through director’s loans
If you want access to the rest of your cash before the end of the year, you can withdraw a director’s loan.
A director’s loan is where you take money out of the company, and keep track of it with a director’s loan account. The account does not have to be a physical bank account, it just needs to be a record of the money going between you and your company.
Director’s loans are still loans, and they have to be repaid within nine months and one day of the end of the company’s financial year. This is where dividends come in - most directors use the dividends that they receive at the end of the year to square the balance in their director’s loan account.
Dividends, director loans and tax
It’s worth unpacking the relationship between dividends and director’s loans a bit more.
The important thing to remember is that dividends are paid after tax. If you’re withdrawing all of your company’s profits every month as part of your director’s loan, you’re going to come up short when the company has to pay tax at the end of the year.
To avoid bleeding the company dry, you need to plan ahead and make sure that you only take the money that will be available after tax and other expenses. Good practice is to pay all of the company’s regular expenses (including employee wages), and then from your profits set aside at least 20% that will cover tax at the end of the year.
If you take out the loan responsibly, you will be able to square the director’s loan account with dividends and HMRC will be happy.
Tax on director’s loans
There are tax issues to be aware of with director’s loans.
You will have to pay income tax on loans of over £10,000, unless the company charges interest in line with the HMRC’s regulations.
The £10,000 figure is not limited to one-time withdrawals, but to any time that the director owes the company at least £10,000. You can’t just circumvent the tax by borrowing in several chunks of £9,999.
The company will also have to pay tax on any outstanding loan amount after the repayment deadline of nine months and one day after the end of the financial year. The tax is 25% of the outstanding amount, and interest will be added to this until the tax is paid or the loan is repaid.
The company can claim the tax back once the loan has been paid, but not any interest.
Other scenarios
We have described director’s loans in the context of a fairly regular monthly payment similar to a wage, but director’s loans don’t have to follow this pattern.
You can take loans out more sporadically or in different amounts throughout the year. You can also take money out for spouses, civil partners, business partners, or close family. In all of the above instances, the same rules of tax and repayment apply.
For further details about director’s loans, their repayment, and tax, head to the government’s official site.
published under Tax and Legislation Guides
