Most small companies start their trading activities by advancing funds via an informal ‘director’s loan’ that in most cases is repaid as soon as the business starts making money.
However, the loan does not have to be in the form of a cash advancement – it can take other forms. For example, if the directors pay for goods or services on behalf of the company, any dividend declared and not paid, or salaries payment not yet taken, this also represents a loan and must be recorded in the director’s loan account.
Repaying the loan would have no impact on the tax liability of a company or the director.
Should a formal loan agreement be drawn up?
It is not mandatory to have a written loan agreement in place, but it is always advisable to formally document a loan arrangement. The agreement should include the interest rate (or range of rates) and repayment date (or range of dates).
Can I charge interest on the loan made to my company?
The director can agree to make the loan without interest or can agree an interest rate with the company. The interest charged can be at any rate but if it exceeds ‘the arm’s length’ rate, there is a danger that the excess may be taxed as earnings for the director, not as interest.
What is ‘arm’s length’ is determined by reference to the commercial interest rate charged by a third-party lender taking into account the size and term of the loan as well as the risk profile of the company.
Is the interest paid by the company an allowable business expense?
Interest charged by the company on a loan is an allowable business expense for the company, but please see question 9.
Does the company have to deduct tax and pay interest net to the individual?
If the loan term lasts for longer than a year, the company must deduct basic rate tax from payments of ‘yearly interest’ made to an individual. Short interest payable on loans in place for a period of less than 12 months is generally outside the scope of the rules.
Companies must account for income tax on a quarterly basis, using a CT61 quarterly return, based on amounts paid and received in the particular quarter.
The quarter ends are based on the normal calendar year, ie 31 March, 30 June, 30 September and 31 December. However, if a company’s year end is different from any of these, the balance sheet date is deemed to be a quarter-end, so there will be five return periods.
Can the company pay the interest gross?
Companies are exempt from the requirement to deduct tax at source on types of interest that fall within any relevant exemption / relief. The main instances where companies can make payments of interest gross are:
payments of interest to another UK company
payments of ‘short’ interest payable on loans in place for a period of less than 12 months
distributions from open-ended investment companies (OEICs), authorised unit trusts (AUTs) or investment trust companies (ITCs)
payments of interest on peer-to-peer loans.
What if I have borrowed the money to lend to my company?
A person that borrowed money in order to lend to the company is entitled to relief for the interest paid on that loan provided that:
the individual works for the company and owns some of the ordinary shares (the full-time working condition), or
they hold at least 5% of the share capital, taking into account shareholdings of ‘associates’ (the material interest condition) and the loan is a ‘qualifying loan’.
A loan taken out by an individual to invest in a company is a qualifying loan if it is:
used to acquire ordinary shares in a ‘close company’ that is not a ‘close investment-holding company’
lent to such a company and used wholly and exclusively for the purposes of the business
used to repay another qualifying loan.
What are the personal tax implications on the interest received?
The interest received on the loan given to the company counts as personal income for the director and must be reported on the director's self assessment tax return and taxed accordingly. If the company has retained tax (on the ‘yearly interest paid’) credit would be given in the usual way.
Can I invest the spare cash in order to receive interest?
Using the company as a savings account has tax implications for the company, such as:
the interest paid on that loan won’t be tax deductible for the company if the funds provided by the director aren’t used for the purposes of the company’s trade
entrepreneur’s relief and/or hold over relief might not be available if a company holds high cash balances on deposits that are not ear-marked for specific business projects, and may be considered not to be trading.