Tax-Free Loans to Directors

Directors of owner-managed businesses can withdraw money from the company account with little or no checks on what is being withdrawn.  A Director’s Account should be maintained for each director, to satisfy HMRC and various accounting regulations.  All financial transactions between the company and each individual director must pass through these accounts.

All payments due to the director such as salary, dividends and expenses will be credited to this account as amounts owing to the director and any payments made to the director will be debited to this account thereby reducing the amount that is owed to the director.

Whilst HMRC have no problem with the company owing you money, the reverse situation with you owing the company money, carries various tax consequences.  You may still be subject to additional taxes, even if you own all the shared in the company, as the company is a separate legal body.

Loans to directors are generally prohibited under Company Law, though loans not exceeding £10,000 are permitted and larger loans may now be made with the approval of the members. There may be some minimal short-term advantages in taking a loan from your company, but ultimately, in the long term, the loan must be repaid or a suitable dividend declared to clear the loan.

Personal Tax Implications
Since 6 April, the exemption limit for tax-free loans to directors has risen from £5,000 to £10,000.  Any loan that exceeds the exemption limit at any point during the year must be declared on the P11d each tax year in which the loan is outstanding.  The benefit of a loan is taxable on the director under the benefit in kind (BIK) rules.

The BIK arises if the loan is a ‘beneficial loan’ i.e. the interest charged on the loan is below the official interest rate as set by HMRC (currently 3.25% for 2014/15). The benefit in kind value is equivalent to the official rate of interest on the loan less any interest paid by the director to the company during the year. The tax payable by the loan recipient will be at their marginal rate i.e. 20/40/45% on the benefit in kind value once calculated on the P11d and the company will also pay class 1A national insurance on this value.

Company Tax Implications
If the loan is not repaid to the company within 9 months of its year end, the company will be liable to pay tax at 25% on the amount of the loan still outstanding at the company’s accounting year end date. It is therefore very important to try and avoid this tax charge, if possible.

If the loan is repaid after the 9 month deadline there is a mechanism for claiming repayment of the 25% tax charge paid by the company, but this repayment can often take up to 21 months.

Bed and Breakfasting
Company directors and shareholders often try to bypass the 25% tax charge by arranging for their company to lend them funds and then repaying those funds just before the end of the nine month period. Immediately after repaying the loan to the company they then take a new loan out of the company. This arrangement, often referred to as ‘bed and breakfasting’, is no longer permitted under new anti-avoidance tax legislation, which considers the intention of directors and the time period in which the new loan is acquired.

The rules relating to director loans are complex and much of the new legislation closes loopholes which have historically allowed individuals and companies to avoid tax on long term interest free loans from their company. It is still however, worth considering short term interest-free or cheap loans as the increased tax free threshold of £10,000 makes it an attractive benefit for directors.

Áine Devine