Occasionally, directors and shareholders of companies in England might need to borrow money from the company they manage and hold shares of.
Let us take a look at the structure and mechanism of such lending, how it affects those involved and the company itself, as well as the points to be aware of.
To put it simply, when a director (and very often shareholder at the same time) takes money from the company which is not to pay salaries, dividends or cover company expenses, it is often considered as a loan to director (Director Loan).
Very often, directors face cash shortages regarding their personal needs. In such cases, directors might cover those expenses using company money by considering it as loan.
This kind of cash withdrawal mechanism was not legal a few years ago, until Companies Act 2006 was amended to legalise it.
However, it is important to know that it can have consequences in terms of taxation. And the amount of tax, depends mainly on the amount of the loan, its form and its repayment time. Needless to say, how the liquidity of the company is automatically affected to meet any future obligations - needs.
1. When the loan to director is less than £10,000 and has been repaid (without interest rate) within 9 months from the end of the company’s tax year, there are no tax obligations.
2. When the loan to director is less than £10,000 and has been repaid (with interest rate) within 9 months form the end of the company’s tax year, the company will have to pay tax for the interest rate received.
3. When the loan to director is less than £10,000 but has not been repaid within 9 months form the end of the company’s tax year, the company will have to pay 32.5% tax.
Note: When the overdue loan is returned, the tax paid is also refunded but any interest rates received are not.
In the event of a written-off loan, the obligation to pay class 1A national insurance applies. The borrower must also declare the written-off loan in Self Assessment tax return and pay the corresponding income tax.
4. When the loan to director is more than £10,000 at any time during the company’s tax year, it should be treated as Benefit in Kind (when no interest is charged above the official limit or not at all), the Class 1A national insurance should be charged, and the director must declare the loan in Self Assessment tax return. The financial - tax burden in such case always depends on the tax rates, which of course, are influenced by the taxpayer's tax scale.
EXAMPLE to case 4:
Loan of £20,000 from the company given for 6 months without interest:
Benefit in Kind will be 2.5% (as for 2017/18) x £20,000 = £500Given that the loan is only for 6 months, it should be equally divided in terms of time, i.e. £500 x 6/12 = £250
As mentioned, this income is taxable based on tax payer’s tax scale.The tax scales are as follows:
➤ Basic rate (20%) – Tax will be £50
➤ Higher rate (40%) – Tax will be £100
➤ Additional rate (45%) – Tax will be £112.5
It is highly important to note that for loans over £10,000 an official approval and a formal decision of the shareholder are necessary, even if there is only one shareholder who also serves as the director.
In any case, recording the financial activity (loans) of the company is a legal obligation for directors.
ALSO INTERESTING AND IMPORTANT: “Bed & breakfasting”
The Government has introduced measures to prevent directors from using methods to avoid paying tax when dealing with loans. Such a method is called “Bed & breakfasting”.
“Bed & breakfasting” applies when directors return the loan just before the end of the tax year and take it back immediately after the new year has started. This will be interpreted by taxman that there is no intention to repay the loan, avoiding thus to pay taxes for capital that has used for personal use.
HMRC's rule: For loans over £10,000, once returned, no further amount can be re-taken within 30 days. And if such case took place, the over £10,000 amount will automatically be taxed.
Finally, it is often the company itself that occasionally needs cash. In this case, things are less complicated:
If no interest rate was charged, the company only has to repay the loan upon company’s request.
If interest rate was charged, the company considers it as company expenses and the borrower as income, which also must be declared in Self Assessment tax return.
Also, when the company pays off the interest rates to the director, it must also withhold 20% tax, record it and submit a CT61 form every quarter to HMRC.
Translated / Edited by, Apostolia Nestoratou.
© 2019 UPECO LTD
ATTENTION! This article intends to give only a general informative picture and should not, in any case, be taken as a rule. It is strongly recommended to seek a full and professional guidance specifically for your circumstances before making any decisions.