As the Director of a company the way you draw money out is often a carefully planned, balancing act.  Most Directors take a minimum salary to remain under the tax threshold.  In addition, they may draw down dividends as well to top up their earnings.  Dividends are subject to personal income tax – as well as having already paid Corporation tax on the profits.

However, there are other ways to benefit from your company’s success.  We’ve written about electric vehicles and pensions before, but not about smart management of a director’s loan account, mainly because, until recently it didn’t offer any significant benefits.  But that’s changed.

If a company loans a director money, interest free, then a benefit arises, the interest that would otherwise have been paid on a loan at market value.  HMRC set the rate for Directors’ Beneficial loans interest and the interest rates, historically, have generally been in line with high street interest rates.  However, this year, while everyone was expecting this interest rate to go up, HMRC announced ‘no change’.

That means that the interest rate is still 2.25%, which, compared to high street rates of around 5-6% even for mortgages, is exceptionally low.  That makes taking a director’s loan a very, very cheap method of raising temporary finance.

The rules

Initially, an interest-free loan from the company to a director, is, effectively ‘free finance’, but it is a loan and loans need to be repaid.  You’ve got 9 months from the company year end to repay it.  In other words, when the next Corporation Tax is due.  Potentially that means you can get as much as 21 months to repay your loan.

If still outstanding when the company Corporation tax is due, HMRC takes a deposit of 39.35% of the loan balance from the company, (this is called a Section 455 or just S455 charge) However, this is refundable when loan is repaid. 

Is it a good solution?

If you need a chunk of money for something specific it’s a very cost effective way to borrow money, but don’t forget that it is a loan.

It’s a good alternative to remortgaging your home or getting a loan from a more traditional lender.

Either make sure there is a way to repay in the required period or be aware of the point at which the Section 455 charge will be payable.  In the latter case you can borrow as much as you want for as long as you want – providing the company has the money available to lend.

If you have a cash-rich company, and don’t want to pay dividend tax and want money to do something specific, it’s a possible means of finance as long as it’s well managed.

Given that commercial banking interest rates are relatively low, it’s challenging to earn more than about 2% with any bank account.  If, as a director, you pull cash out as a director’s loan and either put it into a higher rate personal bank account where you can earn as much as 6%, or with a good financial advisor you could invest it and make a reasonable return, repaying the capital within the period required.

Don’t forget that you will be liable for personal income tax on the profits made by any investments for any interest earned.

Bear in mind that we are not financial advisors and, if you decide to take advantage of increasing earned interest on lump sums, you need to take professional advice.  Whether you make a profit or not, that loan will need to be repaid at some point.