How director’s loans are taxed
Knowing how director's loans are taxed, can help avoid unnecessary costs and penalties. Therefore in this post we'll explain the basics of directors’ loans and how they work. Additionally, we'll cover the key tax pitfalls you can avoid.
What Is a Director's Loan?
A director’s loan occurs when you take money from your company that isn’t classed as a salary, dividend, or reimbursement of expenses. So you effectively have a "current account" with your company. Furthermore, this account records amounts you owe to or are owed from your company.
A director may borrow funds from the company by an agreed loan, as approved by shareholders. Additionally, you can draw funds on account ahead of an anticipated dividend or salary.
Occasionally, by accident or design, illegal borrowing (because it is not shareholder approved) takes place. Moreover, this type of borrowing creates a loan which if not repaid results in tax consequences.
Tax Rules for Directors’ Loans
How director's loans are taxed depends on specific tax rules. The implications depend on the loan’s size and whether it’s repaid. Plus, how it’s treated in the company’s accounts.
Individual's position - overdrawn Accounts and taxable benefits
If a director owes more than £10,000 to the company at any point in a tax year, and no interest is paid, it’s treated as an employment-related loan. This creates a taxable benefit for you as director. The benefit equals the difference between interest at HMRC’s official rate and the actual interest charged (if any).
HMRC indicated in The Autumn Budget this rate will be reviewed quarterly .
As a result, it may increase, decrease, or be maintained throughout the year.
The cash benefit of this interest-free loan for tax purposes is calculated by using an averaging method or on a daily basis. Where there is a difference between the two methods, HMRC uses the daily basis where a loan balance fluctuates throughout the year.
The benefit must be reported on Form P11D. Additionally, your company must pay Class 1A National Insurance Contributions (NICs) on the benefit. For the 2025/26 tax year this will be at the rate of 15%.
However, if you are charged and pay interest at HMRC’s official rate this avoids creating a taxable benefit. This can also simplify reporting and reduce your personal tax liabilities.
Company's position tax charge on outstanding director's loans
Close companies (most small companies) must pay S.455 Corporation Tax on unpaid director loans if they remain outstanding nine months after the company’s year-end. The current rate is 33.75%.
Therefore your director's loan must be fully or partially repaid within this timeframe to avoid this charge.
Any S.455 tax is repayable nine months and one day after the end of the accounting period in which the repayment is made. Furthermore, a repayment claim must be made online and not via the company's tax return.
Where a director's loan is repaid and then a similar sum advanced shortly afterwards, HMRC will apply their anti avoidance rules. HMRC refer to this type of loan transaction as 'bed and breakfasting' When these rules are applied the repayment will be matched to the later advance. This means, no director's loan repayment is deemed to take place.
Aggregation of director's loans
Where two loan accounts are accounted for separately and one is overdrawn, HMRC may try to resist aggregating them for tax. As a result, they will not treat the two as one net balance.
Where you and your spouse or civil partner are directors you can agree between yourselves to allow an offset. This means, one director's loan credit is set against the other's loan debit. However, HMRC will not accept the offset unless there is evidence to prove there is an intention to create a joint loan account.
For this reason, you should agree on the treatment of aggregating or offsetting loan accounts at the time that the loans are made. Alternatively this can be done when the two loans are to be offset.
Ideally, this should be recorded in a board minute at the time. It is better still for the board to pass a resolution to agree on the treatment. We do not recommend back-dating this documentation. There would have to be a genuine reason why it was not possible to record the details of a meeting at the time.
Writing off or releasing an overdrawn director's loan
Invariably there will be tax consequences where a director's (or shareholder's) loan is written off.
A director's loan that is released or written off is nearly always treated as the taxable income of the director. In most small companies the director will be a shareholder and will be entitled to vote at board level, so will be considered a participator.
Where the write-off is made to a director who is a participator the amount written off is taxed as a dividend. Additionally, this tax treatment applies where the borrower is a participator only i.e. not a director.
A director's loan released or written off is treated as earnings for NICs purposes if it is consider salary or profit derived from employment. A loan written off on death is not treated as earnings for NICs, it is considered income of the estate. Additionally, a write-off of a participator's loan who is simply a shareholder is not subject to NIC's.
The amount on which to calculate the NIC liability is the amount of the loan written off. However, broadly speaking where this relates to an non shareholding director or employee the loan is treated as 'net pay'. It will therefore need to be grossed up for PAYE purposes.
Your company will also need to account for any NIC due on the loan write-off via it's payroll and report to HMRC under RTI.
Planning Tips to Manage Directors’ Loans Effectively
Some additional considerations for effectively managing how directors loans are taxed are as follows:
Pitfalls to avoid
Some areas that can cause problems with how director's loan are taxed are as follows:
Summary
Your director's loan can prove useful, however, it comes with significant responsibilities. Understanding how directors are taxed ensures compliance, avoids penalties, and enables better planning. From managing loan balances to planning write-offs, careful documentation and good advice are key to staying on the right side of the law.
For more useful information, check out our Ebooks here.
And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].
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