Director Loans: How should I pay myself?
Ever found yourself pondering the possibility of borrowing from or lending money to your start-up? Given you’re a founder, it’s almost a given that you have entertained this thought.
But, as with all things finance, the terrain of a Director’s Loan isn’t a straightforward path. Before you dive in, it’s crucial to understand what a Director’s Loan Account is, how it works, and most importantly, how to make it work best for you.
Stick with us to discover the what, why and how of Directors Loans, and by the end you’ll find a nifty checklist to keep you on track. But hey, no sneak peeks! It’ll make the most sense after you’ve read the rest of the article.
Friendly reminder: Our write-ups are knowledge pieces and aren’t to be mistaken for personal financial or tax advice. For tailored guidance, come and chat to us!
So, what’s the deal with Director’s Loans?
A Director’s Loan account isn’t your typical bank account. Instead, it’s an accounting record, keeping track of any money transactions between the director and the company, that aren’t categorised as a salary, dividend, or regular business expense.
In simpler terms, if a director lends money to the start-up, or vice versa, the transaction is recorded in the Director’s Loan account. As such, a Director’s Loan account is considered to be in debit when the director owes money to the company, and in credit when the company owes money to the director.
What are Director’s Loans commonly used for?
Director’s Loans can serve various purposes. They might offer a short-term solution to personal cash flow challenges, provide funds for business investments, enable asset purchases, or enable businesses to swiftly address urgent costs without the red tape of external borrowing. It’s vital that such loans are properly documented and compliant with regulations to sidestep potential legal or tax issues.
Let’s examine two different examples of how a Director’s Loan might be used.
Scenario 1: Lending to your your company
Say you’re at the helm of an up-and-coming marketing agency. Bootstrapped with funds from friends and family, you inject funds into your business bank account for essentials like a laptop, domain registration, and a snazzy website to attract clientele. If no shares exchanged hands, and you plan on getting that money back, you’ve created a Director’s Loan. Remember, since it’s a loan, you can decide to charge your company interest, which then gets recorded as business expense in your profit & loss statement. When you eventually get reimbursed, the interest part needs reporting on your Self Assessment Tax Return.
Scenario 2: Borrowing money from your company:
As revenue streams into your agency, you might contemplate drawing funds for immediate personal obligations. Maybe it’s for that car nearing its last mile, or a sudden pile of unforeseen expenses. By drawing more money than your allocated salary or dividends, you’re entering the territory of a Director’s Loan. Tread with caution; it’s essential to assess your start-up’s lending capacity, and to be well-informed about any associated tax repercussions.
Here are three key things to take note of:
- Any loan of £10,000 or more will be treated as a benefit in kind, and must be reported on your annual self-assessment tax return.
- You may have to pay tax on the loan at the official rate of interest.
- For loans of £10,000 or more, seeking approval from all of your shareholders and creating a loan agreement document is advised.
More than just a transaction
As you can see, navigating Director’s Loans can be intricate. It’s not just about borrowing or lending with a quick bank transfer, it’s about the right timing, the correct amount, and the tax implications.
What’s more, wrapped up in the whirlwind of running their start-up, it’s not uncommon for founders to forget all about the Director’s Loan account until the end of their financial year, when their corporate tax is due. They notice this item sitting within the balance sheet – either as an asset (money the director owes the company) or liability (money the company owes the director).
Director’s Loan interest and tax implications
Generally, interest on a Director’s Loan is based on commercial rates. These combine the Bank of England base rate with a SONIA rate – which has taken up the mantle from LIBOR. SONIA is the rate at which banks lend money to and from each other, based on real market transaction data. If you’re keen on getting real-time rates, a quick Google search will sort you out.
Yet, here’s where things get intriguing. If the interest charged on a Director’s Loan is below a reasonable market rate, HMRC will treat the discount granted to the director as a benefit in kind. This means that you, as a director, could be taxed on the difference between the official rate and the rate you’re actually paying. What’s more, Class 1 national insurance contributions will also be payable at a rate of 13.8% on the full value of the loan.
Reclaiming corporation tax on an overdue Director’s Loan
If you have taken longer than nine months and one day to repay your Director’s Loan and have been charged corporation tax on the unpaid amount, don’t fret. You can usually claim this tax back nine months after the end of the accounting period in which you cleared the debt.
However, patience is a virtue here – the wait can be lengthy, and the process a tad cumbersome. As such, it’s best to ensure you don’t end up in this position. One possible workaround is to defer your start-up’s corporation tax payment until your Director’s Loan is repaid.
Given that the deadline for the corporation tax payment is nine months after your financial year-end, it provides a decent window to settle the loan. If you need help with this year’s corporation tax, reach out to discuss your company’s accounts.
Repaying a Director’s Loan and taking out another
The cycle of repaying a Director’s Loan and considering another isn’t just a simple tap on the repeat button. You have to wait a minimum of 30 days between repaying one loan and taking out another. Some directors try to avoid the corporation tax penalties of late repayment by paying off one loan just before the nine-month deadline, only to take out a new one.
This is why you shouldn’t make a habit of relying on Director’s Loans for extra cash.
Taking out a Director’s Loan by accident
It’s not always intentional. Sometimes, it’s possible to take out a Director’s Loan inadvertently by paying yourself a dividend. How does this happen? Let’s look at two scenarios:
✔️ Meet Danielle, a savvy start-up founder who loves hiking. She’s had a stellar year and her company’s showing a profit. Before donning her hiking boots, she checks her company’s distributable reserves, consults her accountant, and then takes out dividends. Voilà! Everything’s above board and she can now enjoy her well-earned break in the Scottish Highlands.
❌ Now, there’s Damien. An enthusiastic founder, Damien thinks it’s Christmas when he sees money in his company account. Without a second thought or a glance at the books, he draws dividends from his loss-making company. Little does he know, he’s just gifted himself an unexpected Director’s Loan. Instead of sipping champagne, he’s now got HMRC to answer to. Always remember: profits first, dividends later.
Your Director’s Loan checklist
In the labyrinth of Directors Loans, there’s plenty to digest. We’ve covered a lot in this article, here’s a succinct checklist we’ve put together to guide you if you are considering borrowing money from or lending to your start-up.
✅ Before diving into a Director’s Loan, ask yourself: “Have I considered all other financing options”
✅ Aim to wrap up any loan within nine months (plus that one extra day) of your start-ups year-end, wherever possible.
✅ Keep borrowings below £10,000. Think of it as staying within the speed limit.
✅ If you venture beyond the £10,000 mark, you must report it on your self-assessment tax return and the start-up must treat it as a benefit in kind.
✅ Wait at least 30 days between taking out different Director’s Loans.
✅ Should you lend money to your start-up, ensure that both you and the start-up use the correct tax treatment.
✅ Ensure that your Director’s Loan Account isn’t overdrawn for extended periods.
✅ Only dip into dividends after confirming that there’s profit on the table. It’s always best to ensure there’s pie before serving a slice.
To wrap things up, think of Director’s Loans as a tool in your financial toolkit – powerful when used correctly, but not something to be taken lightly.
Need a guiding hand? For more in-depth advice on Directors Loans, don’t hesitate to arrange a free call with our Founding UK Director, Elliott Gaspar. He’s here to help guide you through the maze, and ensure you’re on the right track.