Understanding the risks of director’s loans

Personal tax considerations

A director may face a personal tax charge if they borrow from the company at an interest rate below HMRC’s official rate, which is currently 3.75 percent. This applies when the director’s beneficial loans exceed £10,000 at any point in the tax year.

The personal tax cost is usually modest. For example, a higher rate taxpayer with an interest-free loan of £20,000 for six months might expect a tax charge of roughly £150. Even so, these charges should be factored into any decision to take a loan.

Company tax implications

The position becomes more complex when the director is also a shareholder and the company is classed as a close company, as is the case for most owner-managed businesses.

Key points to be aware of:

• No company tax charge applies if the loan is fully repaid by the date the corporation tax is due, which is nine months and one day after the end of the accounting period
• If the loan is not cleared by then, the company must pay a tax charge of 33.75 percent on the balance still outstanding, on top of its corporation tax
• This tax can be reclaimed once the director repays the loan, but this refund may take time to process

The scale of this charge means that sizeable or long-term loans can become expensive if they are not managed carefully. In addition, an outstanding director’s loan can weaken the company’s balance sheet. This can make bank finance harder to secure and may raise concerns among potential investors or customers.

HMRC offers guidance on director’s loans which can be found here.

Partner Sian Connolly comments: “Director’s loans can be helpful in the right circumstances, but problems often arise when they build up over time or are taken without a plan for repayment. It is important to understand the tax impact on both the individual and the company, especially for owner-managed businesses where the lines can easily blur. Good advice early on can save a great deal of stress later.”

If you are considering taking a director’s loan or would like to review an existing balance, our team can help you understand the tax risks and your options. Speak to your usual Forrester Boyd adviser or contact our tax specialists for tailored guidance.