Directors' loans get more expensive

If you run your business through a limited company, make sure you plan carefully how the company will pay you for your services.

As from 6th April 2016, the rate of tax charged on loans to close company participators has risen from 25% to 32.5%. This is so that the rate of tax on these loans matches the increased rate of tax on dividends for higher-rate taxpayers.

Who counts as a participator in a close company?

A close company is a limited company with five or fewer 'participators', or a limited company of which all the 'participators' are also directors.

'Participators' are individuals who have a financial interest in a company, for example, they own shares in the company or have a right to receive shares when the company is wound up, or they have voting power in the company.

Typically, close company participators will be individuals who are both directors and shareholders of the company.

A “loan to a participator” means that the individual owes money to the company, for example if the individual has withdrawn more cash than the company owes to him/her.

Example of a loan to a participator

Jenny is a director-shareholder of her own company, Jar of Jam Ltd.

She uses her own credit card to buy a train ticket to visit her client. This costs her £50. It’s an out-of-pocket expense she’s incurred on the company’s behalf.

She’s also previously lent Jar of Jam Ltd £5,000 in start-up funds.

Jenny takes £6,000 out of Jar of Jam Ltd’s bank account. That’s £950 more than the company owes her.

Unless she decides to treat the £950 as a salary or a dividend and to pay tax on that accordingly, she’ll owe Jar of Jam Ltd £950.

What’s reason for the increased rate?

The new rate was introduced at the start of the 2016/17 tax year with the intention of preventing owners of close companies paying less tax through loans than they would by taking dividends or salaries, since at this date the higher rate of tax on dividends also rose to 32.5% and the higher rate of tax on salaries is 40%.

Had the rate of tax on loans to participators not been increased, then it would have become more attractive to participators to simply withdraw cash from the company, rather than taking a salary or dividend, since the loan would have been taxed at 25% as opposed to 32.5% or 40%.

The increase in this tax rate is part of the tax avoidance measures announced in the Summer Budget 2015.

If you’re not sure what the most tax-efficient way to extract money from a limited company is, speak to your accountant for specific advice relating to your situation.

Want more bookkeeping and tax tips?

Sign up for our helpful guides to claiming expenses, filing your tax return and more.