A transaction is treated being part of a directors loan when a director (or other close family members) withdraws or deposits money from a company that is not salary, dividend, reimbursement for expenses or repayment of money previously loaned to the company.
Overdrawn Directors loan
When a director owes a company money this is called an overdrawn director’s loan.
A director’s loan account may become overdrawn for various reasons.
It may be a short-term loan that a director intends to repay.
It may be by paying for items through the business that a director doesn’t realise are not allowable for tax purposes.
Another way a director may end up with an overdrawn loan account can be due to a director electing to pay a dividend to himself (as a shareholder) and not having sufficient profits to pay the dividend.
This can go unnoticed by a director who doesn’t realise the company hasn’t got sufficient profits to pay dividends, often leading to a large overdrawn balance.
If a director feels the company is under financial pressure then a safer move would be to take salary instead of dividends from the company. It may be less tax efficient (depending on the circumstances) but it will protect the director from building up an overdrawn directors loan balance.
Pitfalls of overdrawn directors loans
Tax to pay
HMRC don’t like overdrawn directors loans and take the view it is potentially untaxed income.
As such, any loan outstanding at the end of a company year that will not be repaid within 9 months and one day is currently subject to a tax rate of 32.5% (rising to 33.75% from April 2023). This tax is called S455 tax and is paid over by the company at the same time as any corporation tax due.
A company can get the S455 tax refunded once a director’s loan is repaid.
If a company was to cease trading, due to an insolvency situation a director is personally liable to repay the loan to the company.
Benefit in kind
A director must also be aware that if their loan account is overdrawn during the year by more than £10,000 they will be subject to a benefit in kind charge if they don’t pay interest on the loan at HMRC’s agreed rate.
There are significant consequences for a company and a director personally in relation to a director’s loan. Gaining a good understanding of a director’s loan account is a key responsibility for any company director.