Cashflow is one of the most important parts of your business to manage. Knowing how much money you’ve got coming in, when it’s available, and if you’re able to use it can make a huge difference to how you conduct your affairs, and how you support yourself.
For Limited Companies, which see businesses taking on a legal identity, using the funds that come in and out of the business is not a simple case of just withdrawing or depositing the desired amount – there need to be proper records kept, and HMRC legislation which must be followed, since the money in the company bank account belongs to the company as an entity – not the individuals who run it.
Director’s Loans are an option available to Limited Companies to allow money to be borrowed from or paid into the company. This can be a very useful tool if the company is having cashflow issues, requires help covering start-up costs, or a Director requires financial assistance that is potentially less expensive and complex than taking out a loan from the bank.
A Director’s Loan is not allowed for money which is being used as a salary, dividend, or expense repayment, or to cover money that has been previously paid into or loaned to the company; and you are required to keep a record of any money you borrow from or pay into the company – this record is what is usually known as a Director’s Loan Account (DLA).
Director’s Loans are not a tax-free option for borrowing money, you may have to pay tax on the loan – and the company may also have to pay tax if you’re a shareholder (also referred to as a Participator), as well as a Director.
Your tax responsibilities will depend on whether the loan account is overdrawn because you owe the company, or in credit because the company owes you – and will also vary depending on the amount of money involved.
There are various forms, such as the CT600A, which need to be prepared for the company tax return to show how much is owed or owing at the end of the accountancy period, and Corporation Tax (CT) may need to be paid depending on the amount borrowed, and potentially interest as well – depending on whether the loan has been paid back in full or not.
If a loan of £5000 was taken out, and then another £5000 or more up to 30 days before or after you repaid it, you would need to pay Corporation Tax at 32.5%. Once the loan had been permanently repaid (within 9 months of the end of your CT accounting period), you would be able to reclaim the CT but not the interest.
If you do not repay the loan within 9 months of the end of your CT accounting period, you would pay CT at 32.5% of the outstanding amount, and interest on the CT would be added until the CT is paid, or the loan is repaid. You can reclaim CT, but not the interest.
If the loan is written off or released (not paid), the company responsibilities require a deduction of Class 1 National Insurance through the company payroll, and the individual who borrowed the loan is required to pay income tax on it through their Self-Assessment Tax Return.
The Consequences of an Overdrawn Directors Loans
Having an overdrawn DLA can be problematic for a Limited Company, in a number of different ways. As we mentioned above, having to pay interest on the corporation tax of outstanding balances can become expensive, but the consequences are not just limited to this interest payment.
The Companies Act 2006 requires that the amount of funds available for distribution is restricted to the amount of distributable reserves available. If the company distributes and draws funds before their financial accounts are prepared, they may inadvertently breech the regulations of the Companies Act by having insufficient retained earnings in balance, making the payments unlawful dividends.
If a Limited Company has Directors Loans outstanding on their DLA, this has to be taken into consideration before distributing the dividends and can reduce the available amount of reserves which are then available.
If the DLA remains overdrawn after 9 months from the end of the corporation tax accounting period, Section 455 of the Corporation Tax Act (2010) allows for a tax charge at the rate of 32.5% on the lower of the outstanding amount.
This amount is payable regardless of the company making a profit or loss, or if there is no CT due. Tax paid under Section 455 is a temporary tax and is repayable to the company by HMRC nine months after the end of the accounting period in which the loan was repaid, but the delay between the loan being repaid, and the tax being refunded can often put a significant strain on a company’s cash flow.
Understanding the intricacies, ins and outs, and applicability of a Directors Loan is crucial if you’re planning to create a DLA with your business. Our advisors have years of qualified experience in dealing with the nuances of working with and for Limited Companies, to ensure their accounts are held to the highest standards of compliance, and making sure financial obligations are met in the best manner for the business.
If you’d like to find out more about Directors Loans, or how we can help you manage the accounts of your Limited Company, get in touch with us for a consultation, and discover why Yorkshire Accountancy should be Your Accountancy service.