When Directors lend money to their company we are often asked about whether they should charge interest to the company. This “simple” example explains the issues and benefits…
Companies often borrow from their Directors as opposed to borrowing from the Bank. As it is an unsecured loan, interest can be charged at a high rate.
If the Company pays interest on the loan, it needs to register with HM Revenue & Customs and prepare CT61 Returns and the CT61 requires the Company to deduct 20% tax on the interest.
The interest received is then declared on the Director’s Personal Tax Return but the interest could be tax free if covered by the Personal Savings Allowance.
The Personal Savings Allowance is as follows:
Basic rate £1,000
Higher rate £500
Additional rate £0
The interest is paid net to the Director(s) or credited to the Director’s Loan Account which is then available to the Director(s) to withdraw as an alternative to salary and dividends.
The interest charges will then be tax deductible by the Company.
A Director is paid net interest of £4,000 on their Director’s Loan Account on 31 March 2019. This would be gross interest of £5,000 less £1,000 for the 20% tax. The Company would need to register with HM Revenue & Customs and file a CT61 with a tax payment of £1,000 by 14 April 2019.
On the Director’s Personal Tax Return they would record the following:
- Interest Received (gross) £5,000
- Less Personal Allowance £1,000
- Taxable Interest £4,000
- Tax due at 20% £800
- Tax deducted at source (£1,000)
- Tax refund due (£200)
In the Company Accounts the following entries would be made:
- Director’s Loan Account would be credited by the net interest amount of £4,000 (£5,000 less £1,000).
- Interest would be charged in the Profit and Loss Account of £5,000 and so the Company would be able to get tax relief at the current Corporation Tax rate which is currently 19% so the Company would make a tax saving of £950.
The net tax cost overall is:
Company pays CT61 tax £1,000
Company saves corporation tax (£950)
Director receives tax refund (£200)
Overall Tax saving £150
In addition, an amount of £4,000 has been withdrawn efficiently or is available to withdraw from the Company.
Please note it is important to discuss this with your Accountant to see if this is appropriate for your business.
Crowthers offer a range of Accounting and Taxation Services. Please visit our Accounts team page for further details.