Friend or foe?
I often spend time with directors of their new Limited Companies explaining the methods of extraction of funds from the company. One of the aims is to help them avoid getting into the situation of an overdrawn directors loan account which then involves calculating potential benefits in kind, preparing the resultant paperwork (P11D’s), NIC charges and one off tax charges, in short a complete mess.
This is because the overdrawn directors loan account is often more due to a businesses lack of control over their finances and understanding about how and what can be drawn from the company. It is also often only discovered on the completion of the accounts by the accountant when the P11D may already be late and the resources may not be available at short notice to rectify the situation before the nine month deadline for the repayment of the loan.
However, ignoring the above scenario a directors loan can in some cases be a much cheaper way for a director to raise finance when done with a bit of forethought and consideration for the completion of the necessary procedures.
What to consider
- Where you borrow interest free from your company you will pay tax on a benefit in kind (BiK). This is worked out based on the official rate of interest, which is currently 4% of the average balance of the loan.
- The company will pay tax equal to 25% of the loan if it is not repaid within 9 months of the year end although this will be refunded when the loan is repaid.
- NIC’s will be payable by the company based on the loan x 4% x 13.8% and payable to HMRC in July following the tax year.
- A P11D form will need to be preapred and submitted to HMRC in July following the tax year.
- The company also has the cost of the interest it will lose on the loan and temporary tax charge.
- To be able to compare the cost we will need to know the cost of getting a loan from an alternative source.
Example
A loan of £50,000 and interest on extending mortgage say 5% for 5 years.
Interest payable on alternative finance – £12,500
Directors tax bill – £4,000
Company’s NI (net of Corporation Tax relief) – £1,104
Loss of interest to company – £5,163
Overall saving – £2,233
Conclusion:
Although there have been recent changes to the rules the tax and NI costs of borrowing from your company is usually less than you would pay on funds from other sources. However this should be done with consideration of the commercial interest rates available at the time and with advice regarding the necessary paperwork and deadlines so there are no penalty costs to be included.