Directors’ Loans: Legal Rights and Obligations

As a business owner with a limited company, you might take a director’s loan from your business for your personal use. If you have fellow directors, they could also take out a loan. Director’s loans can help you with, for example, unexpected expenses. However, you must understand and abide by the legal rules concerning taking out these loans, such as having a director’s loan account, the tax implications and shareholder approval. If not, you could face repercussions such as tax penalties. Director’s loans can also cause business disputes, which can take up your business resources. Therefore, this article will explore your legal rights and obligations concerning director loans so your business can avoid a director loan dispute. 

What is a Director’s Loan? 

A director’s loan is where you, as a company director or a close family member, take out a loan from your company. It is usually taken to cover short-term or one-off expenses.

You must comply with some essential legal rules when handling director loans. Therefore,  it is necessary to note that the loan is not:

• a salary payment;
• repaying expenses;
• a dividend (unless you take these when your company cannot afford them, in which case they are considered a director’s loan); or
• your business repaying a director for their previous loan to the company.

Legal Rights and Obligations 

There are various rules about director’s loans. For example, there are specific rules about obtaining shareholder approval, which not abiding by can result in civil penalties. Also, you must keep the financial transaction records for the loan in a director’s loan account (DLA). 

Financial transactions include directors taking out the loans and their transactions to pay them back. Each director should have a separate DLA, and you are legally obliged to record every transaction relating to the director’s loan.  For example, any cash withdrawals from the business or personal expenses using company funds.

However, taking a director’s loan of over £10,000 will be treated as a ‘benefit in kind’, so you must include it on your tax return. 

Tax Rules

There are also tax rules regarding directors’ loans, which depend on the amount of the loan and the borrowing period. Understanding the tax rules for director’s loans is essential, so you should seek professional advice regarding these. 

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For example, if you are slow to pay back a director loan, this can result in a significant tax penalty. If a loan is not paid back within nine months of the company’s year-end, there is a 32.5% corporation tax charge. Although you can claim this back when you pay the loan back, it does not include any interest paid. Also, the process to recover the tax is a long one. 

Loan Disputes

Disputes can arise as a result of directors’ loans. These can occur when directors fall out with each other and want the other to repay their loan. Director loan disputes can also arise because a company enters insolvency. This is because they are a company asset that can benefit the company’s creditors. 

Hence, an office holder may chase for repayment. You may be able to challenge, for example, a liquidator or administrator trying to recover the loan. However, it is more likely that they will try to resolve this amicably directly with you. 

You could also get into a legal dispute if you don’t follow the direct loan rules we explained earlier. If you are involved in a director’s loan dispute, it is crucial to take legal advice, as it can be very complicated.  

Key Takeaways

A director’s loan is when a director or close family member takes a loan from their company. It is often for a small amount and for the short term. This article has examined some of the legal rules about directors’ loans. For example, you are legally obliged to keep a director loan account (DLA) for each director who takes loans, and tax rules can apply to director’s loans. In addition, director’s loans may need to be approved by shareholders. Unfortunately, a director’s dispute can arise due to a director’s loan not being paid back. This can be, for example, when a company goes into liquidation. You could also get into a legal dispute if you do not follow the rules regarding director loans. 

If you need help understanding director’s loan disputes in the UK, LegalVision’s experienced disputes and litigation solicitors can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. So call us today at 0808 196 8584 or visit our membership page.