How do you loan money to your company?5 Oct 2015
Lending money to your own business
Many new businesses struggle to raise startup capital until they have proven their business model and gained some traction. When funding is hard to come by any capital requirements over and above the company's equity capital is often funded by loans from company directors, which are then repaid as the new company begins to generate revenue.There are both legal and tax pitfalls associated with director loans - good advice at reasonable cost offers peace of mind. We can help with all aspects of director loans, both tax and legal, so give us a call or email us.
Established companies also borrow money from directors from time to time, either because they lack an alternative source of growth capital or because borrowing from a director offers the company better terms of credit than other available options.
Another common scenario which we are asked about a lot is whether directors can and should borrow money from a company, whether this is legitimate and what the implications are for the company and/or the director. See more on this below.
Company loans can also involve money lent to employees or loans between companies which are part of a group corporate structure.
Director lending money to company – check legal aspects first
The first step is to make sure the company's Articles of Association allow the company to borrow money from directors, and double check whether the Articles impose any special terms or restrictions on these loans. If you are unclear about what your company's Articles of Association allow for it could be worth speaking to a small business accountant before proceeding.
Assuming the loan is allowed, the next step is to draw up a loan agreement setting out the date and size of the loan, the agreed rate of interest and the repayment schedule.
It is always advisable to formally document a loan arrangement and we offer a cost effective, experienced service – talk to us about how we can help.
Director loan account
While a director can obviously make a loan to the company in the form of cash, the loan can also take other forms. For example, if a director pays for equipment, products or services on the company's behalf, or if he or she foregoes salary payments for an agreed period of time, this also represents a loan by the director to the company and must be recorded in the Director's Loan Account.
Can directors charge interest for loans to a company?
Yes. The director can agree to make the loan without interest or can agree an interest rate with the company. If interest is charged on the loan it counts as personal income for the director and must be reported on the director's Self Assessment tax return.
The company is required to deduct Income Tax from the interest payments at the basic rate of 20% prior to paying interest to the director, and must pay this Income Tax to HMRC every quarter using form CT61.
It is important to keep a record of any loans directors make to the company, whether they involve cash loans, deferred salary payments or payment for products or services on the company's behalf. These loans are recorded as credits in the Director's Loan Account (DLA), and will be reported as current liabilities on the balance sheet when the company files its annual statutory accounts.
The company will not have to pay corporation tax on any loans from company directors.
Loans from a company to a director
It is perfectly possible and legal for a director to borrow money from a limited company. However, the tax implications are quite complex both for the director and the company and advice is strongly recommended. We can help.
There are also legal formalities to consider such as the company articles and Company law as regards formal shareholder approval for loans over £10,000.00. Company directors have fiduciary duties to act in the best interests of the company (effectively the shareholders) and if the company has more than 1 director and shareholder or different directors and shareholders, simply assuming that it’s ok to borrow from the company is risky. In other words, directors of small companies should be careful to remember the company’s interests are separate and not the same as the directors.
Issues to consider with director borrowing from a company typically include :-
- Interest rate on loan and repayment terms. A low interest rate or interest free loan can create significant tax liabilities.
- Whether the loan will constitute a benefit in kind in which case there will be National Insurance costs to the business and income tax aspects for the borrower.
- The overall Corporation tax figure which can depend on whether the loan is repaid quickly or whether it remains outstanding for a considerable period.
If you need tax, legal or commercial advice and assistance on director borrowings from a limited company, please do get in contact.
Company loans to employees
Loans made to employees are also permissible legally and for tax purposes. Many of the same principles apply as for loans to directors and consideration should be given to the implications of lending an employee more than £10,000.00 in tax terms.
Interest free loans are also allowed and are quite common, especially for specific work related expenses such as travel.
Complications with loans to employees which may differ from loans to directors are the possible Consumer Credit type implications and employment law related issues. For example, there are dangers in having a subjective, merit based policy on employee loans which cannot be objectively justified. In the absence of a clear, consistently applied policy, there are dangers of claims of discrimination. Other complications might be whether the loan repayments can be deducted contractually from salary and if not, what if the employee does not make repayments? Whilst that may be a clear breach of a loan agreement/employment contract, it may not entitle the employer to dismiss based on that breach.
Good advice and clear and consistent policies, documents and tax records are essential. We would be happy to assist with all or any of these.
Inter company loans
This is a highly complex area. As a quick introduction to the topic, we start first with the reasons inter company loans between group or connected companies are quite commonly used :-
- Cashflow – loans between connected companies avoids the inherent delay, cost and hassle in applying for 3rd party finance.
- With external finance or borrowing security is often demanded and/or a degree of control ceded. This doesn’t have to happen with an inter company loan.
- Lending can be on unusual terms not potentially available in the commercial lending market such as longer repayment terms.
Potential disadvantages to an extent cross over with the advantages :-
- There are dangers in loans appearing not to be on commercial terms, such as interest rate.
- There are complex rules with tax consequences to consider.
- Inter company loans are quite commonly written off over time. Don’t assume the loss can necessarily be deducted by the lending entity for tax.
We are experienced in advising on all aspects of directors loans and company loans, whether relating to the documents needed or the tax and business considerations arising.Check out our full range of accounting services here or even get an instant quote for your business today.