Director Loan repayment with Dividend Income - Tax implications

[coolguycp1]

I took out director’s loan of £10,000 from my Ltd. company in May this year to purchase a car. The repayment plan was based on making regular equal payments deducted from my declared dividend income back into the director’s loan account. I intended to pay back the directors loan fully before the 9th month after the end of my current company accounting period (any interest under Section S55 will not be due then).

However, as the directors loan repayment is planned to be paid back from the dividend income, am I right to think that if the total dividend drawn for the current tax year takes my total income above the basic rate rate tax band, I will essentially be paying 25% tax on the repayment amount to the directors loan?

Will I be better to pay off the directors loan by taking a personal loan which will certainly at a lot lower interest rate? Are there any other options too?


Thanks

[TheFaQQer]

If you take additional income (either as a salary or a dividend) which makes you a higher rate taxpayer, then you would pay additional tax on that amount over the threshold.

If you don't repay the loan in full, then the company will charge you interest at 3.25%. If at any point during the tax year the director's loan account exceeds £10k, then the company will charge you interest at 3.25% on the loan - be incredibly careful about how you account for anything and don't miss the figure by even the tiniest amount or you have to pay interest.

If you can get a better personal loan over the repayment period, then you would be better off doing that - I don't know what rates personal loans are charging these days, but 3.25% as a loan from the company looks pretty tasty to me.

Crunch the numbers and see what the best option is, and check with your accountant as well to make sure you aren't inadvertently leaving yourself open to the worst of both worlds.

[northernladuk]

Why do people take such big amounts out of their company without a fully understanding what they are doing? Why did you not get your accountant to explain it all to you first?

For that amount why not try looking at balance transfer or money credit cards with low balance transfer rates. Not all will allow you to forward cash to a current account but some will.

[Contreras]

If you don't repay the loan in full, then the company will charge you interest at 3.25%.

I wasn't aware of that. I think the OP is more concerned about the 25% tax take though.

If at any point during the tax year the director's loan account exceeds £10k, then the company will charge you interest at 3.25% on the loan -

Especially as the interest is profit to the company, so the effective cost is 20% of 3.25% = 0.65%, I think.

[northernladuk]

I thought TF had already factored that in? The standard rate of interest he has to charge is 4%

[TheCyclingProgrammer]

My reading of OP is that they were more concerned with not paying the s455 tax by ensuring the director's loan is paid off before 9 months after their tax year. As long as the loan account doesn't exceed £10k interest or BIKs should not be an issue.

As to the question of whether or not you should take out a personal loan to clear the director's loan and then repay this over a longer period or pay it off using a dividend but potentially pay higher rate tax...isn't that fairly easy to work out?

a) Work out the amount of higher rate tax you'd pay if you declared a dividend to clear the loan in full (assuming company has enough retained profit to cover the dividend) that you otherwise wouldn't normally pay.

b) Work out how much a personal loan would cost you over however many years you need to take it out for to keep the repayments affordable.

c) Also consider any other potential issues with taking on a personal loan (credit issues)

At worst, assuming you still owe the full £10k and you've fully utilised your basic rate band, the you'll need to declare an approx. £13.3k dividend to cover both the outstanding DL and the higher rate tax, so a tax bill of approx. £3.3k.

On the face of things, a personal loan will surely be cheaper unless you don't have much DL left to clear? I took out a £7500 loan over 3 years with my bank (First Direct) earlier this year to pay for a new car at around 4.6% which will cost me about £500 in total interest.

Of course, there is the third option which is to not repay the loan within 9 months of the year end, but just keep making regular repayments to YourCo. You'll have to pay s455 tax on the outstanding balance at the end of the 9 months so it will cost YourCo initially, but you will be able to reclaim this 9 months after end of the year in which you paid off the loan so it may end up being the cheapest option long term, assuming YourCo has the cash-flow to manage the temporary tax.

Agree with NLUK though - before you took the DL out, why didn't you have a contingency plan already in place if you didn't think you'd be able to pay it off in time?

[TheCyclingProgrammer]

I thought TF had already factored that in? The standard rate of interest he has to charge is 4%

Didn't HMRC reduce this recently?

Edit: yes, they finally caught up with the fact that he base rates are so low. It's 3.25% as TF said.

http://www.hmrc.gov.uk/rates/interest-beneficial.htm

But as long as OPs loan remains under £10k there is no interest to pay at all.

Your idea about using an interest free credit card isn't a bad idea either.

[TheFaQQer]

I thought TF had already factored that in? The standard rate of interest he has to charge is 4%

Not for 2014-15 - it's 3.25. It was 4% last tax year.

Linky

[coolguycp1]

Thanks for providing all the inputs.

At the time I decided to take out the directors loan, I had planned my personal cash flow calculations for the current tax year such that I would remain below the higher rate tax threshold even when I included the regular repayments for the directors loan from the dividend income.

However, my personal commitments/expenditures have increased (due to unforeseen issues), resulting me having to draw higher dividend income. This is likely to put me in the higher rate bracket.

I am still planning to keep the repayments to the directors loan as planned. The only way to remain in the basic tax band is if I repay the directors loan by taking out a personal loan, so that I am not having to draw dividend income for repayment which will attract a 25% tax rate. The personal loans APR for upto £15K are currently in the region of 5-6% which is certainly below the dividend rate of tax on higher tax band. Is this the right approach?

I agree that I should have been more clever at the time of taking out the loan, but you only learn from your mistakes, I suppose !!

[TheFaQQer]

The personal loans APR for upto £15K are currently in the region of 5-6% which is certainly below the dividend rate of tax on higher tax band. Is this the right approach?

Taking a personal loan at 6% to repay a loan that you would pay 3.25% on doesn't seem to be smart to me. Maybe I'm missing something here.