Loans Between Companies and Directors/Shareholders

Companies commonly enter into loan arrangements with individuals, particularly with shareholders or directors. The reasons for this vary but the need to introduce funds to cover cash requirements that cannot be met in any other way is a common motivation. On the other side of the coin, some directors or shareholders do use the company to meet personal expenditure.

There are, of course, tax implications for individuals and companies making, or taking, such loans. Read on for a brief guide to the main points that you should be aware of:

Loans by companies to individuals

Loans to shareholders

Leaving aside companies that are in the money lending business, the most common instance where a company makes a loan to an individual is when a director/shareholder either takes cash advances or arranges for the company to pay personal bills and thereby generates an overdrawn loan account with the company. The loan account often consists of many transactions, including both advances and repayments. Although such loans are in contravention of the Companies Act they are, in fact, quite commonplace and, consequently, there are rules designed to levy tax charges when they arise.

When a company makes a loan to an individual who has an interest in its share capital or voting rights, tax at 25% is payable by the company on any amount outstanding at the end of the company's accounting period. This tax is payable nine months from the end of the accounting period.

The tax can be avoided in the following situations:

  • If the loan does not exceed £15,000 and the shareholder's interest in the company is less than
    5%, or
  • To the extent that the loan is repaid within nine months of the end of the accounting period in which it was advanced. The 25% charge will only be applied on the amount outstanding at the end of the accounting period, but not repaid within nine months.
  • Once paid, this tax is not necessarily gone forever
    – it can be recovered nine months after the end of the accounting period in which the loan is repaid (or part recovered if the loan is part repaid).

Loans to employees - beneficial loan interest

If a company loans money to an employee (and this includes directors) and the loan exceeds
£5,000, a 'benefit in kind' arises to the extent that the interest rate charged on the loan is less than the 'official rate'. The official rate is a rate set by the government and it currently stands at 4.75%. This benefit must be reported by the company on the individual's form P11D each year and tax will be collected either through PAYE or

as a result of the personal tax return process.

Loans written off

If a company writes off a loan to an individual, the tax treatment depends on the status of the individual. For an employee, the write-off will be subject to PAYE (as if it were salary). In the case of a shareholder who is not an employee, the individual is taxed as if a dividend had been received.

Loans by individuals to companies

Income tax on interest payments

Where an individual has made an interest-bearing loan to a company and the loan lasts long enough for the interest to be considered to be yearly interest, the company must withhold tax at 20% and pay only the net amount to the individual. The income tax is then paid over to the Revenue on a quarterly basis.

Higher rate taxpayers will need to personally pay tax of a further 20% in order to ensure 40% is paid overall.

Income tax relief

Where an individual has borrowed money from a third party and then uses it for a 'qualifying purpose', it may be possible for them to get tax relief on the interest suffered.

The most commonly encountered qualifying purpose is the purchase of shares in, or the making of loans to, a 'close' trading company in which the individual has either a material interest (5%) or has a lesser shareholding but is also an employee. Broadly speaking, a close company is one that is controlled by its directors or five largest shareholders.

Loans written off

If the company is unable to repay the loan and the individual has to write it off then a capital loss may arise under the loans to traders provisions. This loss can then be offset against current or future gains on which tax would otherwise be payable. This is a broad outline of the rules affecting loans between individuals and companies.

Should you require additional information relating to the tax treatment of loans, please contact Charles Green on 020 8652 2450.

Should you require additional information relating to the tax treatment of loans, please contact Charles Green on 020 8652 2450.

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