What is a director’s loan?

We dropped a mention of “director’s loan” on Free-Work back in January 2024 but with a fair few red flags accompanying it, so let’s clear up what a director’s loan is, and how limited company directors can put them to proper use, writes Christian Hickmott, managing director of contractor accountancy firm Integro Accounting.

What is a director’s loan?

Put simply, a director’s loan can either be money that the director has lent to a limited company, or conversely, money that a limited company has lent to the director.

Either way a director’s loan can be a useful mechanism!

Funds are often lent to a company by the director(s) when getting a fledgling business up and running, for example.

The other side of the coin…

On the other side of the coin, lending to a director from the business can be a practical way of stabilising your income if you find yourself with inconsistent income streams between one tax year and the next.

It’s no coincidence we wrote about inconsistent income as a limited company IT contractor last week for Free-Work, and are now here demystifying what a director’s loan is and entails!

And if you do find yourself facing an inconsistent income between one tax year and the next, a director’s loan could be the answer, as there’s little point paying higher or additional rate income taxes if you know that your income in the next tax year is going to be more modest, with space to spare in the lower rated allowances.

Why does director’s loan have a bit of a stigma?

So why does the phrase “director’s loan” cause a flicker of a frown to flit across many an accountant’s face?!

And why did we accompany introducing director’s loan with those few red flags?

Well, in short, it’s all thanks to tax rules and regulations set by HMRC; and the concept of ‘illegal’ dividends.

In fact, while a director’s loaning of funds to their business is generally straightforward, the complications and intricacies of a director’s loans arise out of directors borrowing from the limited company.

So, let’s delve into the borrowing from the company aspect of a director’s loan in more detail, and explore how to do it correctly.

Beware, the ‘illegal dividend’ scenario

Director loans are often linked to the concept of an illegal dividend and as such can carry negative connotations.

If a company has made an error in calculating its profits after tax and issued dividends to its shareholders over and above the funds that were available for distribution as dividends, then a director’s loan is often the vehicle used in an owner-managed business to mitigate this error in the accounts.

This is the limited company accounts equivalent of going OVERDRAWN!

And so it can be the starting gun of a downwards cashflow spiral, because -- as the company’s director -- you will have effectively borrowed from future profits.

Corporation tax payable

There are certain scenarios whereby the limited company must pay corporation tax on a director’s loan that it has made.

This corporation tax can often be reclaimed, but only nine months and a day after the end of the accounting period in which the repayment was made.

The up-to-date thresholds, rates and circumstances for paying corporation tax on a director’s loan can be found on HMRC’s website, and are very much worth checking.

Benefit-in-kind taxes

If you have made a director’s loan of more than £10,000 to yourself as a director from a limited company, then you will also need to declare the loan, and any difference between the official rate of interest and the interest you have actually paid, as a benefit-in-kind.

This means that the loan and interest saving must be declared on your self-assessment tax return, and it falls liable to Class 1 National Insurance.

Director loan best practice when borrowing from a limited company

Despite all the rules, regulations and bureaucratic pitfalls there are times when a director’s loan can be useful, meaning the stigma to director loans isn’t always fair or warranted!

If your contractor limited company has more profit retained on the balance sheet than it needs for healthy trading, and you have sufficient cashflow to embark upon the corporation tax payment and reclaim cycle, a large director’s loan of over £10,000 may ultimately be cheaper than borrowing from a third-party.

Where an accountant for a director’s loan is strongly recommended

Unless you have first class organisational skills and are confident with the HMRC rules surrounding director loans however, this is not something to embark upon without professional help.

If you do take the riskier road and go it alone, there are three things to keep in mind that can make the most of the attributes of a director’s loan in the short term, while avoiding some of the greater complexities.

What are those three? I’m glad you asked!

Top three director’s loan tips as a limited company to avoid HMRC trouble

1. Make sure that you have the profits in the company i.e. can the business afford to loan the funds to the director?

2. Keep the loan under £10,000.

3. Make sure you repay the loan in full within nine months of the end of the accounting period in which the loan was made.

Director’s Loan: Good or Bad?

Neither really, but potentially ugly if you wade into taking a director’s loan from the company without advice, and get things wrong!  

In our experience of the contracting accountancy space, a director’s loan can often be useful and it can often potentially require the careful guidance of an accountant.

In short, a director’s loan is typically used as a handy short-term tool in the director’s arsenal of income and tax planning. But do proceed with caution, and chat it through with your accountant or tax adviser first, especially if you’re looking to borrow from the company.