What Are Director’s Loans & How Do They Work For Tax?

A loan from your company can be a useful tool but there are two tax charges which can apply where your company lends money to you as a director and if you control 5% or more of the company’s ordinary shares.  These are also known as Director’s Loans.

The first is a temporary charge on the company and the second is more permanent and is taxed on the director who borrowed the money.

The only way to reduce the tax charge on the director is for this person to pay interest (at an official rate of interest – currently 2.5%) on the loan but this payment of interest has no effect on the tax payable by the company.

This interest should be calculated as soon as possible after the end of each tax year but must be no later than six months after the end of each tax year.

There have been recent examples of dispute with HMRC where this interest has then been debited to the director’s loan account. HMRC have argued that this is just an accounting entry and it didn’t count as an actual payment of interest.

This is correct as debiting a director’s loan account for interest will not count as payment, unless there is more than one loan account and the debit is made to the one which is sufficiently in credit to cover the interest.

For this to apply each director’s loan account must be clearly maintained separately in the company’s records.

It is only in the above case that the interest could be regarded as paid and on this basis alone, the tax charge should be cancelled by HM Revenue & Customs.

However in order for this to be completely successful, it is imperative that there is a formal written agreement between the parties regarding the interest. This ensures that the payment of interest is legal and can therefore legitimately reduce the tax charge.

 

If you would like our help to understand the implications in more detail for your specific situation, call us today on 02392 449732 or click on the ‘Request Call Back’ button below and we will be happy to have a chat.

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Posted in Tax & Accountancy.

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