Using a Director's Loan for Quick Access to Funds
Recently, one of our clients suffered a flooding issue and needed £10,000 at short notice to fix and replace various damaged parts of his house. The flooding damage was covered by insurance, but he wanted to move fast and get things replaced right away.
He agreed with his insurance company on all the work that needed to be done, and they agreed all the costs. However, to help speed things up, he wanted to pay for things himself and then get his insurance company to reimburse him directly. The cost of the building work and replacement items was £10,000, but our client did not have that sort of money sitting in his personal bank account.
He had his own limited company and knew that his company bank account balance was currently £17,000. He was curious to see if he could access that money in the short term to fund the building work that needed to be completed. He knew that within about 1-3 months, his insurance company would be repaying him this money, so it was just going to be a short-term funding solution.
How did it turn out, and what issues did he face? Lets get into the detail now.
Short Term Funding Requirement
Following a recent flooding event in his community, our client was facing significant water damage, requiring immediate repairs and replacements to prevent further deterioration of his property. The good news? His insurance covered the damage. The bad news? Insurance companies aren’t known for being the faest payers in the world, and he wanted to get the clean-up work done ASAP. He wanted to manage the repairs on his own terms, ensuring quality workmanship and swift action, rather than relying on the insurance company’s potentially slower processes. He agreed with the insurance company on the necessary work and the £10,000 cost, and they confirmed they would reimburse him directly.
The catch? He didn’t have that kind of cash readily available in his personal account. While he knew his limited company held £17,000 in its business account, he wasn’t sure if he could use those funds, and what the accounting and tax impact might be. He was confident that the insurance payout would arrive within 1-3 months, making this a short-term funding need. Traditional lending routes like bank loans or increasing his credit card limit seemed like a pain given the urgency of the situation, so he got in touch with us to spill the tea.
Company Financial Position
The first thing we looked at was the financial position of the company. This involved ensuring the reconciliation was complete and that all current invoices, expenses, dividend payments, etc., had been correctly accounted for.
After completing the reconciliation for this client, the company had retained earnings of just over £2,000. For our contractor clients, retained earnings is effectively the net worth of the business. If the business were to collect all its debts and pay all its creditors, it would be left with £2,000. That’s one way of thinking about retained earnings.
So in this case, although the business did not have enough retained earnings to cover the £10,000 loan, it did have a bank balance of £17,000, which indicates to us that this business had upcoming tax liabilities that it needed those funds for.
The question then was whether those tax liabilities were due within the next few months or if the business could afford to temporarily pay out a short-term loan to the director to fix their flood-damaged property.
In this particular case, the client’s year end was 31 July 2024 and they had a corporation tax liability of £12,000. As we know, corporation tax is due nine months and one day after the company year end, so in this case the company was due to pay its corporation tax by 01 May 2025.
The company was also VAT registered and filed VAT returns every quarter. By examining the company’s cash flow over the last six months, we knew that the company would still be able to maintain sufficient funds to pay its quarterly VAT liabilities, even if £10,000 was temporarily withdrawn from the business bank account.
So at this stage, the main question was whether he would be able to get his £10,000 back by the 1st of May 2025? He knew from his discussions with the insurance company that they would be paying him out by Christmas at the absolute latest.
Therefore, he was confident that this would not impact his business cash flow and that he would be able to get the funds from the insurance company in time.
Tax Impact of Taking a Loan
So, we now know that the company will be able to cover its upcoming tax liabilities with its current cash flow and that it can afford to pay a £10,000 director’s loan to our client.
The issue now becomes understanding the accounting and tax impacts of taking a £10,000 loan from his business.
- Loan Interest
In this particular case, the director’s loan was exactly £10,000, so there were no loan interest or benefit-in-kind charges to consider. But let’s quickly go through these rules so that you understand how this works.
Firstly, if the loan balance does not exceed £10,000 at any point in a financial year, the benefit-in-kind rules in relation to interest-free director’s loans do not apply. If, however, our client’s loan was going to exceed £10,000, then the loan is automatically classed as a benefit in kind. This means that the company will be liable for Class 1A employer’s National Insurance, and the cost of the benefit will be reported on the client’s personal tax return, on which they would then pay tax.
The benefit-in-kind charge is based on the value of the loan and the HMRC-approved beneficial loan rates rate, less any loan interest that was paid by the director back into the business.
The easiest way for our clients to navigate the benefit-in-kind rules when their loan exceeds £10,000 is to simply pay loan interest at the HMRC-approved rate on the balance of the loan back into the business bank account. When the loan balance has interest paid at the HMRC-approved rate, there is no benefit in kind, which simplifies calculations and reporting.
The HMRC-approved rates for director’s loan interest are low, with the current rate for 2024/25 being 2.25%. Taking this a step further, paying loan interest into your business bank account is effectively another form of income for your business, which you can then extract as dividends or a salary, depending on how your company is set up.
So, when you pay director’s loan interest into your business bank account, all you are really losing is the corporation tax that would get paid on that income, along with any personal tax related to drawing that money out as a salary or dividend.
- Section 455 Tax
Section 455 (S455) tax is a “Charge to tax in case of loan to participator” to use the phrasing from Corporation Tax Act 2010. Essentially for our limited company clients, if they are a shareholder in the business (which they are) and if they take a loan that meets the S455 criteria, then a S455 tax charge will apply. The current S455 tax charge is 33.75% of the outstanding loan balance nine months after the accounting year end, which makes it a very important tax that must be considered.
S455 is a temporary tax that gets repaid by the HMRC when the participator re pays the loan back to the business. It can be a cash flow issue for clients, making it an incredibly important text be aware of when taking a loan from your business.
The S455 tax applies where a loan has been taken from the business (by a participator) and has not been repaid within nine months after the end of the accounting year in which the loan was made.
In the case of our client, they were taking a loan from their business two months into the new financial year and would be repaying the loan within the same financial year. For this reason, no section 455 tax would be due, which again makes this loan transaction very simple from an accounting and tax perspective.
Outcome
After completing a reconciliation for the client’s account and considering the loan interest and section 455 tax implications, the loan transaction for this particular client turned out to be very simple. He simply transferred £10,000 from his business bank account to his personal bank account, and those funds were used to repair the flooding damage to his property.
The transaction was recorded in our accounting software as a director’s loan, and after our analysis, our client knew two things: (a) there would be no interest due on the loan because it was at the £10,000 benefit-in-kind threshold, and (b) the loan would be repaid in time to avoid the section 455 tax charges.
In practice, once our client receives the £10,000 payout from the insurance company, he will simply transfer those funds back into his business bank account, which will then reduce his loan balance back to zero.
So, in this particular case, he was able to raise £10,000 very quickly by using funds in his limited company bank account and will suffer no interest charges or additional tax charges. It was a very simple way for him to get hold of some short-term funding.
FAQ’s
Can I use a director’s loan for personal expenses?
Yes. When you take a director’s loan from your business, those funds are transferred into your personal account for you to use for whatever purpose you like. There are no rules around what the funds are spent on at all.
How much can I borrow as a director’s loan?
This is a really important question and requires some analysis of your business accounts to determine how much the business can afford to lend to you. The main things to think about here are; (a) The loan interest that you will need to pay back into your business based on the value of the loan using the HMRC beneficial loan rates; (b) The cash flow your business needs to ensure it can pay its liabilities on time. Cash flow can be a real problem where the loan remains outstanding for more than nine months after your accounting year end, and where Section 455 tax must also be paid.
If you plan on taking a substantial loan from your business, make sure you get in touch with us first so that you fully understand the accounting, tax, and cash flow impacts of taking money from your business bank account.
How do I avoid Section 455 tax?
If your outstanding loan balance on the last day of your company financial year is fully repaid within the following nine months, then no Section 455 tax will apply.
What if my company is facing financial difficulties?
If your business is facing financial difficulties, we strongly suggest not taking any loan from your business, as this tends to just make matters worse. Ideally, if you do need to take a loan from your business, then your business should have sufficient retained earnings to cover the entire cost of the loan. Where retained earnings are not sufficient, ensure from a cash flow perspective that your business can still afford to pay all of its tax liabilities, even while missing the money that has been paid to you as a loan.