Understanding Director’s Loans: All you need to know

What is a director’s loan and how do they work?

Navigating the intricacies of accounting often involves understanding concepts like director’s loans. In this article, we’ll delve into the fundamentals of director’s loans, shedding light on what they are and how they work. From clarifying what constitutes a director’s loan to unravelling how they operate, we’ll provide you with a comprehensive overview of this essential aspect of accounting.

What is an overdrawn director’s loan?

An overdrawn director’s loan is a financial transaction in which a company’s director borrows money from the company itself. This type of loan can encompass various forms, including cash withdrawals, personal expenses paid by the company, or even using company assets for personal use.

An overdrawn director’s loans must adhere to specific legal and tax regulations to prevent abuse and ensure proper corporate governance. In addition, these types of loans must be documented, charged at an appropriate interest rate to avoid tax implications, and repaid within a stipulated timeframe. Failing to meet these requirements might result in financial penalties or tax liabilities for both the director and the company.

What is a director’s loan account?

A director’s loan account is a financial record that tracks the transactions between a company and its director when money flows in either direction.

It keeps a detailed record of all debits (money borrowed by the director from the company) and credits (money lent by the director to the company) over time. This account helps monitor and manage transactions that aren’t considered a salary, dividends or expenses.

Clear documentation and adherence to legal regulations are crucial to avoid tax liabilities. If the account remains in debit at the end of a financial year, tax implications can arise for the director.

What are the benefits of a director’s loan?

Business owners could seek to earn interest on directors’ loans, subject to reviewing any tax implications.

Even though the rate of interest charged by HMRC on late tax payments is currently 6.75%, (base rate plus 2.5%),  with the base rate being due for review on the 20 March.  The rate charged on a beneficial loan for 2024/25 is much lower at 2.25%, with the average rate rising to 3.75% from 06 April 2025. Therefore, taking a company loan could be an attractive option for directors.

There will be no benefit in kind for 2024/25 if a director’s beneficial loans do not exceed £10,000 at any point throughout the year.

Company tax charge

The tax treatment of a director’s loan is complicated because there is also a company tax charge if the director is a shareholder and their company is a close company. For owner-managed companies, this will generally be the case as close companies are usually companies with five or less directors/shareholders.

• The tax charge is at the rate of 33.75% on the amount of the loan should the loan still be outstanding nine months and a day after the end of the company’s accounting period in which the loan is made.
• However, this tax charge is refunded to the company if the loan is subsequently repaid by the director.

When might you take out a director’s loan?

A director might take out a director’s loan for various reasons. However, taking out a director’s loan allows you to access additional funds beyond your current salary and/or dividend earnings. Director’s loans are typically used to cover short-term or one-off expenses, such as financing personal projects or addressing urgent financial needs. It’s important to note that director’s loans should be temporary rather than long-term solutions.

At the end of the fiscal year, the director’s loan account (DLA) will indicate either a debt owed by the director to the company or a sum owed by the company to the director.

Nonetheless, they involve significant administrative tasks and carry associated risks (like the possibility of substantial tax penalties). As a result, they should not be employed as a regular practice but rather maintained as a contingency option for obtaining personal funds in emergencies.

Lending to a company

You can also opt to extend a director’s loan in the opposite direction – by lending money to your company.

This could be a suitable choice if you intend to inject funds into your company for purposes like sustaining its ongoing operations or acquiring assets. Should you decide to apply an interest charge, any interest that your company disburses to you will be categorised as income and needs to be documented in your self-assessment tax return.

The company regards the paid interest as a business expense, and it’s required to deduct income tax at the source (at the basic rate of 20 per cent). Any higher rate tax due would be assessed through your self-assessment tax return. These deductions need to be recorded and submitted on a form CT61 and tax paid to HMRC every quarter.

Once recorded in financial documents, the loan account balance appears in creditors, and the company can repay funds when cash flow permits.

Reporting requirements 

Loans to directors must be disclosed in the corporation tax return and reported to HMRC. They may also require disclosure in the statutory accounts under the relevant financial reporting framework, which could be either UK GAAP or IFRS.  

Repaying director loans

All borrowed funds must be returned to the company. In the case where the director holds shares in the company, it might be feasible to balance the loan by declaring a company dividend.

The repayment of a director’s loan is required within nine months and a single day from the company’s fiscal year-end; otherwise, a substantial tax penalty will be incurred.

Should any outstanding amount persist beyond this duration, it will be subject to a 33.75 per cent corporation tax charge, referred to as S455 tax. This tax, temporary in nature, is held by HMRC and is refundable upon future return submission, reflecting loan repayment or reduction.

What are the tax implications of director loans?

Tax consequences vary based on the amount borrowed and its duration, potentially leading to tax implications for outstanding debts owed to the company.

Benefit in Kind Tax on low-interest or interest-free loans 

Should the sum owed surpass £10,000 within the tax year, a benefit in kind (BIK) will occur, except if the director is already paying interest to the company on the loan. Notably, this aligns with the tax year, not the company’s financial year, necessitating meticulous and consistent record-keeping. BIKs must be declared on P11d forms, and penalties are applicable for untimely submissions. The director must report this on their Self-Assessment tax return, and it is subject to Income Tax. 

National insurance contributions (NICs)

While there is generally no National Insurance due on the loan itself, if the loan is written off or released (i.e., the director is no longer required to repay), it becomes taxable as employment income. In such cases, Class 1 NICs may be due on the amount written off, payable by both the employee and the employer. 

Additional tax on written-off loans

If a director’s loan is written off, the director will face additional tax liabilities. The written-off amount is treated as income for the director and is subject to Income Tax at their marginal rate. 

Potential for avoidance of dividend tax

HMRC pays close attention to situations where loans to directors might be used to avoid paying dividends, which would otherwise be subject to higher tax rates under the dividend taxation rules. Hence, careful consideration and compliance with HMRC rules and documentation are crucial to avoid unintended tax consequences. 

Record keeping for the director’s loan account

Maintaining meticulous records for the director’s loan account is imperative. Accurate documentation of all transactions, borrowings, repayments, and interest charges ensures transparency and compliance with legal and tax requirements.

In addition, precise record-keeping aids in assessing whether the account is overdrawn and subject to tax liabilities or benefit-in-kind implications. This includes not only the initial loan amounts but also any interest paid, relevant dates and supporting documents.

Regular updates to the loan account, reflecting its current status, are essential for effective financial management and to avoid potential penalties or misunderstandings.

Get in touch

Rayner Essex offers invaluable expertise in navigating the complexities of director’s loans. With comprehensive understanding of legal, financial and tax implications, we provide accounting solutions that ensure compliance and optimal financial management. Rayner Essex will be happy to assist you through this intricate aspect of corporate governance.

Disclaimer: Please note that this document is not intended to give specific technical advice and should not be construed as doing so.  It is designed to alert clients to some of the issues and not intended to give exhaustive coverage of the topic.  Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.