Directors Loans – What You Need To Know

Loaning money TO your business

Many directors will loan the business money in order to fund operations until the business starts generating enough cash flow on its own to be self-sufficient.

Often startups forget or don’t realise that a business is a separate legal entity and is treated as such, even if it’s owned by you or you and a business partner.

So, if you put money into the business, that money is treated as a loan and as such the company owes you that money – regardless of the fact you own the company…

Any money put into the company will go down as a liability on the balance sheet and is a liability to you personally. At any point, assuming the company has enough funds you can draw that money back and clear off the debt without paying any tax.

For example:
You have put £10,000 into the business.
You could draw down £1,000 per month for 10 months tax-free as it would be offsetting against your director’s loan. You’d effectively be repaying your directors loan in instalments.

Loaning money FROM the business to a director

If you are withdrawing money from your company and not either declaring it as a dividend or a salary then it will go down as a directors loan. This means that you owe the company money.

To remove it, you can choose to repay it, take this as a salary (and pay the tax accordingly) or as a dividend declaration.

For example:

You are taking £1,000 per month from the company for a 12 month period.
Therefore the company is owed £12,000 by you.
You can either now say it’s a mixture of salary and dividend to clear the loan (and pay the tax accordingly)
Bear in mind you can only wipe the loan out if you have enough reserves.
So if the business earned £10,000 and you have a £20,000 directors loan – only £10,000 of that loan can go.

If you don’t clear the loan, by either repaying it to the company or putting it down as a salary/dividend within 9 months after year-end then the company will have to pay what is known as a section 445 corporation tax on the loan. Which at the time of writing is 32.5% on the balance outstanding – ouch!

However, as soon as the loan is cleared you will receive the money back from HMRC.

(The only reason you wouldn’t be able to clear the loan is if you didn’t have the funds in the business)

But how can I draw more money than reserves?

Clients often wonder “How can I draw more money than reserves?”

Well often businesses get investment or loans, they then draw that cash out for one reason or another, perhaps for living expenses and then go overdrawn in the director’s loan account.

Many startups get a startup loan and draw a small wage out of the business. But by the nature of new businesses, the first year can be challenging. The business may not be making a profit.
Then, when it comes to year-end you may be faced with a large tax liability of 32.5% if you have been drawing money from the business.
You do however get that money back once cleared but it can really affect your cash flow.

If you’re a startup or business looking for a trusted accountant to help you on your journey – give us a call at RJF. We specialise in businesses like yours and are happy to help.