If your director’s loan account is in the red by the end of your company’s financial year, do you know the most tax-efficient option to manage it? Should you write it off to avoid a charge on the company? Can a director’s loan be written off? If you’re unsure of the answers to these questions then read on to find out more about directors loan repayment rules.
Will I be taxed on a director’s loan account?
Let’s start with the director’s loan account basics. A 2.5% charge applies to the average balance of the debt. The exception to this is if your balance never reached £10,000 during the tax year. In this instance you will pay no tax on director’s loans. However, the tax percentage your company must pay is much greater. A 32.5% fee is charged on the amount you owed at the end of its financial year if the debt is not repaid within the nine months. This fee applies even if the amount is below £10,000.
Is there any way around the tax charged to the company?
HMRC rules state that you can avoid the 32.5% tax if the director’s loan account is paid off within the nine months. However, you will need to find the money to repay this. The company cannot subsidise this. This is because any money you receive will be subject to tax and possibly NI contributions. This is prior to using the net figure to clear the director’s loan account. An example of this is as follows:
If you’re in the higher tax bracket and pay 40% on your salary and you owe your company £10,000 you’ll need an extra £17,241 gross pay to have enough left to settle what you owe.
Can a director’s loan be written off?
To work around this, your company can write off the debt. This allows it to be viewed as taxable income and not extra salary – making it more tax efficient. If you are a shareholder in your company and your director’s loan is written off, you will pay a lower tax rate than what you pay on your salary. For this to apply, your company will need to pay you more money so you pay the tax, but the tax rate will be 32.5% not 40%. Again, this is more tax-efficient than it being paid as extra salary.
Here is an example of how this can work:
Bob owes his company, Acom Ltd, £20,000 at the end of its financial year, which ended on 31 March 2019. To avoid the 32.5% tax charge he draws extra salary in July 2019. The PAYE tax and NI on this is payable by Acom in mid-August 2019. If instead the debt is written off the resulting tax bill for Bob won’t be payable until 31 January 2021.
Is there anything I should know before writing off a director’s loan?
You may be let off on tax when you write off a director’s loan. However, NI is not so forgiving. According to HMRC, a loan write-off still counts as earnings. Therefore you will pay NI on the amount. It’s important to note that in most cases if an NI bill is factored in a write-off, it is usually less tax efficient than salary. HMRC view the money as “remuneration or profit derived from employment”, which is correct. However, if you are also a shareholder in your company and you can prove that it was because of this position, NI will not apply. It can be hard to prove this though as HMRC often pushback on these cases.
Are there any other options?
An alternative option is that your company pay a dividend equivalent to the amount of debt. This will give you the same tax outcome.
We can help
If you’re looking for answers about tax on director’s loans or for expert director’s loan account advice, head to our website today. Thomas Nock Martin can help you determine the most financially beneficial option for a repayment of a directors loan to a company. Alternatively, you can call us on 01384 261300.
If you have found this blog helpful, you may wish to read our previous blog on What is Working Capital?