The tax traps of director’s loans – How to avoid unnecessary charges
Director’s loans can be a useful way to access company funds, but if not managed properly, they can lead to unexpected tax liabilities.
With HM Revenue & Customs (HMRC) increasing the official interest rate for beneficial loans from 2.25 per cent to 3.75 per cent from April 2025, directors must be even more cautious about how they handle these loans.
What is a director’s loan?
A director’s loan occurs when a director borrows money from their company that is not salary, dividend, or expense reimbursement.
While this can provide short-term financial flexibility, it comes with strict tax implications if not repaid correctly.
The nine-month repayment rule
If a director borrows money from their company, it must be repaid within nine months and one day after the end of the company’s accounting period.
If the loan remains unpaid beyond this deadline, the company incurs a tax charge under Section 455 of the Corporation Tax Act 2010 (the Act).
This charge is currently 33.75 per cent of the outstanding loan balance.
How to avoid this:
- Repay the loan before the nine-month deadline to prevent the tax charge.
- Consider declaring a dividend or increasing salary payments to cover repayment, but be mindful of the tax implications.
Personal tax liability on cheap or interest-free loans
When a director receives a loan at a rate lower than HMRC’s official rate (which rises to 3.75 per cent in April 2025), the difference is considered a Benefit in Kind (BIK). This means:
- The director is taxed on the difference between the interest they actually pay and the official rate.
- The company must pay Class 1A National Insurance contributions (NICs) on the benefit.
How to avoid this:
- Pay interest on the loan at or above the official rate to eliminate the benefit in kind.
- If using a beneficial loan, ensure it is accounted for in payroll and benefits reporting.
Writing off or releasing a loan
If a company writes off a director’s loan, the outstanding amount is treated as income for tax purposes. This means:
- The director is taxed as if they had received a dividend or additional salary.
- The company may also face tax implications on the written-off amount.
How to avoid this:
- Ensure that loan write-offs are planned carefully, considering alternative repayment options.
- Understand that a written-off loan may not always be the most tax-efficient approach.
The impact of the new interest rate change
From April 2025, the interest rate for loans calculated using the precise method will rise to 3.75 per cent, increasing the cost of borrowing from a company.
However, the rate for the averaging method is yet to be confirmed and currently remains at 2.25 per cent.
How to avoid this:
- Use the averaging method if it remains lower than the precise method.
- Compare the cost of a directors’ loan against other borrowing options, such as dividends or commercial loans.
Director’s loans can be a valuable tool, but they must be managed carefully to avoid unexpected tax liabilities.
With the upcoming changes in interest rates, it is even more important to plan loan arrangements effectively.
Need help managing the rules around director’s loans? Speak with our team of tax experts today to ensure your business stays compliant while making the most of available financial options.
