The tax rules on using a director’s loan account

We know that small business owners face so many challenges when you’re running your business by yourself as a limited company director, but did you know that getting a personal loan doesn’t have to be one of them? One benefit of running your own limited company is the potential to access easy director’s loans for your own personal use, whether that’s to fund an emergency like a broken boiler at home or to temporarily plug a short-term cash flow issue like paying school fees.

We’re going to explain all about how to use a director’s loan as well as the rules you’ll need to be aware of to avoid falling into heavy tax payments. 

What is a director’s loan?

A director’s loan is a specific method of transferring money between a company and its director. It is different to other ways of extracting funds from a limited company such as by taking salaries or issuing dividends because a director’s loan can issue money to both the company as well as the director. When using a director’s loan, a director’s loan account is opened which is recorded on the company’s balance sheet as either an asset or liability depending on which way money has been allocated.

What are the different types of director’s loans?

There are two types of director’s loans:

1. Borrowing money from the company – this is where you personally as the company director borrow money from your limited company. Unlike salaries or dividends, and as the name suggests, it is a loan which should be paid back to the company. This will show as an asset (debtor) on the company’s balance sheet and is also seen as an overdrawn director’s loan account.  
2. Lending money to the company – in some situations, you may want to lend money from your personal account to your company. A common example of this is when you are first starting up and you need to purchase assets for your business, but your company is yet to start making its own money. This will show as a liability on the company’s balance sheet and can be referred to as a director’s loan account in credit.

What are the different types of director’s loans?

Taking out a director’s loan can make life much easier than applying for a personal loan from a bank because it’s often quicker and cheaper to do so. Firstly, there is no application process. Where you’re the sole director and shareholder of your company, you’ll simply authorise yourself to withdraw the funds (make sure you record this accurately on your bookwork however). If you do have other shareholders in your company, then you’ll generally only need their permission to take out a director’s loan for sums of £10,000 and over unless your company’s articles of association say otherwise.

Secondly, you’ll often find that a director’s loan can be taken out for much lower interest rates than those of ordinary external lenders. HMRC sets an official rate of interest (ORI) but there is no legal obligation that you follow this. There are however tax implications if you choose to offer the director’s loan at lower interest rates than the ORI or no interest at all.

Despite the attractive reasons to take out a director’s loan, we would advise that you should still consider it carefully before doing so. This is because there can be costly and heavy taxes applied to both you and your company if the terms and repayment of the loan do not fall within HMRC’s rules. Although taking out a director’s loan is generally recommended as a last resort for short-term borrowing, there are no rules as to what you can use the loan for. So, feel free to use the money to book that long-awaited family holiday or for that home extension – the loan is for you to use personally as you wish. 

How much can I borrow from my company?

One big key attraction to taking out a director’s loan is that there is no limit on how much you’re allowed to borrow. Of course, the amount should be within reason, considering important factors such as how much your company can afford to lend you as well as your own ability to repay it.

Depending on how much you choose to borrow, the loan can become subject to various taxes including income tax, national insurance, P11d tax, and corporation tax. In most cases, a tax liability will arise where you take out a director’s loan of £10,000 or more within a year as well as if you fail to repay your company within the director’s loan repayment deadline.

Do I have to pay interest?

This is a good question, as with most other third-party loans, you would expect to pay interest on any amount you borrow. With director’s loans however, there is no legal requirement to charge interest. Yet as we’ve mentioned, HMRC sets an ORI which applies to director’s loans. For the tax year 2024/25 this is charged at a rate of 2.25% which is currently significantly lower than the Bank of England base rate.

So, why would you charge yourself interest if you don’t have to? Technically, where you opt to charge 0% interest or a lower rate of interest than the ORI, this is seen to be a benefit-in-kind (BIK) which would ordinarily attract Employer’s Class 1A NI contributions at a rate of 13.8% for the company as well as income tax for yourself personally. On a practical level however, so long as your director’s loan is repaid in full by the deadline then you could avoid the P11D tax implications. A hugely important note to make on this point is that this will only be the case where you are not frequently taking out director’s loans from your company and avoiding the interest payments as HMRC may interpret this as disguised salary instead.

For director’s loans of £10,000 and more, this automatically constitutes a BIK. Therefore, Employer’s Class 1A NI needs to be paid by the company and income tax needs to be reported and paid for through your self-assessment tax return. One way to avoid this is for your company to charge you interest at a minimum of HMRC’s ORI but be aware that the interest payments are seen as earnings for your company and therefore subject to corporation tax.

On the other side of the coin, did you know that you can also charge your company interest on any money you loan it? Should you choose to do so, our advice would be to ensure you are in line with other third-party commercial lender rates to prevent HMRC questioning you. Interest payments are subject to income tax and therefore need to be reported on your personal tax return but are tax-deductible against corporation tax for your company.

When do I have to repay my director’s loan?

In an ideal world, director’s loans should be repaid in full within 9 months after your company’s financial year end. This date coincides with the deadline for completing your annual statutory accounts and is because your director’s loan account is recorded on your balance sheet – which needs to be submitted as part of your annual accounts. If you have not repaid your loan, it will show as overdrawn and alert HMRC that certain taxes will need to be paid. 

For instances where you have lent your company money, you can withdraw any amounts as repayment at any time tax-free (this of course should be logged on your accounting records).

How much tax is charged on an overdrawn director’s loan account?

If you’ve failed to repay your loan in full within 9 months after your company’s financial year end, then HMRC imposes a heavy tax penalty on your company known as Section 455 corporation tax. This is charged at a whopping rate of 33.75% – substantially higher than the main corporation tax rate of 25% and even more so for those companies eligible to pay the small profits rate of 19%. It is intended to prevent abuse of director’s loans.  Not only that, but interest is further charged until the corporation tax has been paid or the loan has been fully repaid.

The good news is that you can reclaim this tax once your director’s loan has been paid off in full, although the interest payments cannot be. Unfortunately, the downside to this is that it is a slow process and must be manually claimed for (it is not refunded automatically). You can only do this 9 months after the financial year end of when the loan has been repaid. 

How do I repay my director’s loan?

When you want to repay your director’s loan, you’re able to do this in three ways:

1. Pay from your salary. As you’ll know, director’s salaries can be paid by your company regardless of whether it is in profit or not whilst this also reduces your corporation tax. If you want to repay your director’s loan from your salary, you can simply use your payroll to allocate your salary or a portion of it to clear down your director’s loan account instead of receiving it into your personal account.
2. Pay by issuing dividends. If your company has enough surplus profits to do so, you can issue dividends and again allocate them to paying off your director’s loan account. When paying dividends, you’ll have to create a dividend voucher and so there should be sufficient evidence to show HMRC how you have repaid your director’s loan.
3. Pay by cash from your own personal account. This is by far the least contentious way you can repay your director’s loan as it’ll provide sufficient evidence to HMRC that you have repaid your loan through your own means.

Can I take out another loan once I’ve repaid?

You may think that there is an easy loophole to avoid the section 455 penalty tax where you could simply repay the loan before the repayment deadline and then withdraw another loan after. This tactic is known as ‘bed and breakfasting’ and HMRC are also aware of this! As such, they have enacted a 30 day rule which restricts directors from taking out another loan from their company within 30 days of repaying one. HMRC are also highly observant, so even where you take out another loan after 30 days, they may have cause to question it if this is done too regularly. This adds to one of the reasons why director’s loans should only be used for one-off situations.

Can I just write off my director’s loan?

The simple answer to this is yes, but the bigger picture is that it’s far more complicated. Writing off a director’s loan means your company waives its right to be repaid but does not necessarily guarantee that you won’t have to repay! Where you write-off a director’s loan where you owe money to your company and the company becomes insolvent, liquidators may seek to recover the loan from you personally.

With regards to how this will impact your tax liability, the money owed will be treated as dividends and you will have to pay income tax at the dividend tax rate. Your company will have to pay Class 1A NI and the written-off loan is not tax-deductible against corporation tax. It can be a very costly consequence and in general will not look good for the company which could adversely impact you when trying to secure loans from external lenders in the future or where you were to seek out investors.

Get help with your director’s loan

As you can see, there’s a lot to consider before taking out a director’s loan. If you’re not sure whether it’ll be the right decision, then our team of tax accountants can support you with tailored advice for your personal circumstances as part of our wider annual accounts, company tax return or self-assessment tax return services. Get in touch today via our online form.