A director’s loan is be a loan of funds from the business to the director. It can also be a loan from the director to the business. A director’s loan is treated in the same way as any other creditor and, like any form of lending, has to be repaid. From an accounting perspective the chart of accounts should show a directors loan account for each director, even if it sits at zero.
The directors loan account can also be used as the account through which mileage and expenses are managed as it acts as a creditor’s account for the director that needs to be repaid. These ‘normal’ transactions are not necessarily a loan but ensure that the accounts show that the business owes the director money. A loan is different.
Is it OK to have a director’s loan?
It’s not uncommon for a director to loan a company money to assist with growth, asset purchases or cashflow. When a director puts money into the business this is shown in the accounts as a creditor and there would normally be an agreement around the terms and repayment of the loan. There are no external rules around the terms of director’s loans and each instance is down to the company and individual to agree. Some directors may forego interest whilst others may link it to current bank lending rates. There may only be an issue if a director charges what could be considered a punitive level of interest on their loan, as this could be considered as additional income outside the usual tax implications associated with salary (PAYE) and dividends.
If a company does pay interest to a diirector it cannot be paid gross. Tax is deducted by the company and paid to HMRC, normally on a quarterly basis. When the Director completes a personal tax return the tax paid by the company on the interest will be offset against the personal tax liability.
So in short, it’s perfectly legal for a director to loan a company money.
Adverse director’s loans
On the flip side, a company can also loan a director money. Again, there should be terms around the purpose and repayment of the funds. Directors can be debtors in the same way as any sales customers owing the business money would be treated. Whilst a director’s loan into a company doesn’t carry any external rules, a loan from the company to a director does. Here the director must repay the loan within nine months of the company’s year-end. If it is not repaid within this time frame it will be classed as an overdrawn director’s loan and has to be disclosed as such. A company will face a tax charge on loans that haven’t been repaid within the nine month time frame with the outstanding balance being subject to a tax charge.
There is more potential for the tax authorities to take a dim view of a loan from the company to a director and not just for the reason above. For instance, a company should not be loaning money to a director if it is unable to meet its other commitments. This could look like fraud and suggests that a director is trying to extract funds prior to the collapse of the business. HMRC may also question why the company is loaning the director funds and whether this is an alternative means of profit extraction – again outside of the tax schemes for PAYE and dividends.
If you’re considering putting money into your business as a director or taking it out, it’s worthwhile seeking advice from an accountant on how best to manage things. In addition, before putting any money in or taking it out, make sure to set out an agreement with all fellow directors and specifically shareholders so they are fully aware of the terms. Wherever possible, it is best practice for any money being loaned to the business to be borrowed equitably from all responsible parties and repaid in an even manner too.
To discuss any aspect of your business accounts please get in touch.