The use of Director’s loan interest can be a tax-effective method of extracting money from a Limited company and should be considered along with salary, rent, and dividends.
The reason being is that the interest payment is an expense in the company’s accounts, which reduces the profits chargeable to Corporation Tax.
If a Directors Loan Account has built up over time, such as initial start-up capital from the director, personal funding for asset expenditure, or dividends not yet taken as cash, and if the company is profitable (or expected to become such) it can be sensible to charge the company interest on this loan which is owing to the director.
The interest (which can be at a commercial rate that 3rd party lenders would otherwise offer) can be accrued and paid out when cash flow permits. Such interest rates could be up to ~8%. However, this interest rate would need to be able to be justified to HMRC.
For a director (assuming a non-higher rate taxpayer) if they were to take an interest payment of £2,000 instead of dividends, the effective take-home pay could be ~£500 more, as the interest payment does not attract any further tax deduction, whereas the dividend payment does.
Such interest needs to be reported to HMRC using form CT61, and the corresponding tax deduction at 20% needs to be paid over by the company too. Typically the interest on a director’s loan is often declared on 5 April and the tax paid by 14th July.
Even though any interest payment is more beneficial than dividends, there is additional administration involved in the calculation of average interest and preparing the CT61 forms, so the interest payment should ideally be substantial enough to justify this work. We would typically recommend an interest payment of at least £2,000 or higher.
As with all tax planning and profit extraction, we recommend you discuss this with an accountant as there can be many other factors which may impact this.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.