A director’s loan is when you (or other close family members) get money from your company that is not:

·       a salary, dividend or expense repayment

·       money you’ve previously paid into or loaned the company

What is an overdrawn Director’s loan account?

If a director receives a payment that is not part of their standard remuneration package (generally salary and dividends), the payment is normally applied to their director's loan account. The only other option is to classify the money as a bonus, but bonuses can be expensive in terms of tax and National Insurance.

 If the director's loan account has a balance, they can draw money from it without incurring any tax or reporting obligations. It's as if they have a bank account that they may access whenever they want, as long as the account is in good standing.

 When the available funds are depleted, however, the director is in default and becomes a business debtor.

What happens if you don’t pay back a Director’s Loan?

 Corporation tax charge: S455

After the current accounting period ends, you have nine months to repay directors loans.

After that, you'll be assessed a 32.5 percent corporation tax penalty on the loan amount (known as S455 tax).

There will be national insurance and income tax implications if the loan exceeds £10,000, as HMRC will assume the director is using the money for salary.

If you are unable to repay the money you have taken from your firm, you may be forced into personal bankruptcy.

 Because an overdrawn director's loan account is practically an interest-free loan, S455 is intended to prevent the firm from giving its directors such lucrative incentives. S455 is unique in that it is a temporary loan that is reimbursed to the company by HM Revenue & Customs (HMRC) as the director repays the loan to the company.

Relief is due immediately if the loan is repaid within nine months of the end of the accounting period, i.e. the S455 is never physically paid (but declaration in the company's tax return is still necessary).

 Beneficial Loan benefit in kind

An overdrawn director's loan account might also result in a benefit in kind for the so-called "beneficial loan." An overdrawn director's loan account, as previously stated, is practically an interest-free loan. As a result, the director is subject to taxation on the interest that would have been due if the loan had been made on the open market (the calculation of which is stipulated by HMRC).

P11Ds are the returns for Benefits in Kind. By July 6th, you must provide HMRC with copies plus the P11D(b) (which reveals the company's Class 1A National Insurance liability). The P11Ds will detail the events surrounding the overdrawn director's loan account over the course of the tax year.

It is critical to complete the P11Ds and P11D(b) on time if your director's loan account is overdrawn and you believe it will exceed £10,000 at any stage during the tax year. If your P11D(b) is late, you will be fined £100 per every 50 employees for each month or part month the return is late. If you pay HMRC late, you'll face fines and interest.

Connect Cheylesmore Chartered Accountants if you are struggling in understanding your expenses which can lead to heavy tax penalty.