As many of you might know, getting a loan from a bank when you are a business owner can often be quite difficult and much harder than if you were making a similar amount of money as an employee, I wanted to discuss an efficient way to borrow money using spare cash that’s left in a limited company.
Firstly you might be thinking that having spare cash in a business is a bit of a fantasy but with more and more business owners being advised by their accountants to stop withdrawing cash once they have used up their basic rate tax band, this is actually becoming more common.
It’s common place for directors to be owed money by their limited companies, after all they generally have to invest money to start the business and this often is left sitting there as a debt, but once the company has paid this money back it possible to be overdrawn on a directors loan and owe the company money.
After a director’s loan is overdrawn things start to get a bit more complicated, you can borrow as much money as you like but if it’s not paid off within 9 months of the companies year end then HMRC will automatically charge you 25% of the outstanding loan value.
This 25% is refundable when the director’s loan is repaid so while it might seem extreme the true cost is actually the interest that would have been earned if the money had been kept in the company bank account which at today’s interest rates is generally very low.
If the balance is overdrawn by more than £10k at any one time then there is also a benefit in kind charge where a notional interest rate is placed on the loan by HMRC (~4%) and then the director is charged income tax in the same way they might be for private healthcare or a company car.
The cost to the director would essentially be the notional interest rate times their tax band, for example as a higher rate tax payer it would be 40% x 4% = 1.6% which is still cheaper than getting a loan from the bank, there will also be a small class 1A national insurance bill for the company.
The director’s loan used in this way can be a great tool for giving a director access to more cash without having to pay higher rate tax or borrow from a bank, if the company’s trading slows down later on then dividends can be issued to wipe out the loan and recover the 25% tax charge.
As an accountant based in Northampton, I work with my clients to ensure that they withdraw money from their business in a tax efficient way and they stay on the right side of the rules, if you would like some advice on the best way to take money out of limited company then please get in touch.