Director’s loans – are you a Director and lending money to your Company?

Directors’ Loans

You may not be aware but there is a whole raft of legislation that seeks to penalise directors and shareholders if they borrow money from their companies. These regulations include possible tax Benefit in Kind charges for the directors/shareholders plus an additional Corporation Tax charge of 32.5% for the company for directors’ loans.

In effect, the tax system discourages directors from using their company as a private bank account.

Company borrowing from Directors

But what happens if the reverse situation occurs and a director/shareholder lends money to their company?

If a company requires long-term funding, this “loan” could be made by the issue of shares, in which case the shareholders may be entitled to future dividends. As shareholders, they would then also usually get to share in the spoils if the company was subsequently sold or wound-up. But once capital is used in this way to buy company shares, it is difficult for shareholders to recover their investment without going through a complicated and expensive legal process.

Instead of taking shares, a director could simply choose to lend money to the company. This is best done by agreeing terms and drafting a formal loan agreement between the company and the person lending the funds. This agreement should set out the terms for repayment, specify the security offered by the company and most importantly, detail the calculation and rate of any interest that will be paid by the company to the director for the use of the funds.

The last point is significant. Many directors of smaller companies simply deposit funds in their companies and take them back when they feel that they are no longer required. But by doing this, they may be missing out on a tax-free – albeit small – income stream.

As an example, the person lending the money could be entitled to the £1,000 or £500 personal savings allowance. A loan of just £16,000, with an agreed interest rate of say 6%, would generate an annual income for the lender of just under £1,000. If the lender was a basic rate tax payer they would be entitled to the £1,000 tax-free allowance. The company could also benefit by being allowed to deduct the interest payment when calculating its taxable profits.

As always, the devil is in the detail and there are a number of issues that need to be covered to ensure there are no traps for the unwary.

If you are considering loaning capital to your company from your own funds or wish to review any past loans made with a view to formalising them, then please contact our tax team on 0800 6520 025 to find out more.