Directors’ loans – which loan should you repay first

Many directors find themselves in a position where their company owes them money – whether from drawings taken in advance, personal expenses covered on behalf of the business, or formal loans extended to the company. Equally, many companies owe money to their directors. The question of which loan to repay first isn’t just a matter of cash flow management; it’s a tax and accounting matter that deserves careful consideration. In this post, we’ll walk through the practical considerations and help you understand the implications of your repayment strategy.

The difference between director’s loan accounts and formal loans

First, let’s clarify what we’re dealing with. A director’s loan account (DLA) is an informal arrangement – essentially a running tab of money flowing between you and your company. It’s recorded in the company’s books but doesn’t typically have formal loan terms, interest rates, or repayment schedules. A formal director’s loan, by contrast, has documented terms: interest rates, repayment dates, and conditions.

Why does this matter? From a tax perspective, informal director’s loan accounts can trigger significant complications if they’re not managed properly. If the company is in debit (meaning it owes you money), that’s generally fine – it’s treated as a debtor balance on the company’s balance sheet. However, if you’re in debit (meaning you owe the company), this becomes a beneficial loan, and HMRC’s anti-avoidance rules come into play.

Understanding the Section 455 tax charge

Here’s where things get serious. Under Section 455 of the Corporation Tax Act 2010, if any director or shareholder has an outstanding loan from the company that exceeds £15,000 at the end of a tax year (9 months after the year-end), the company faces a tax charge of 32.5% on the amount outstanding. This is in addition to the corporation tax the company already pays on profits.

This charge is punitive by design – it’s meant to discourage directors from using their companies as personal bank accounts. Importantly, the charge applies to the full amount outstanding, not just the interest element. And it’s not a one-off: if the loan remains outstanding next year, the 32.5% charge applies again.

So, if you have a formal director’s loan outstanding that exceeds £15,000 at the end of the tax year, repaying that loan becomes a genuine priority. The cost of not repaying it – in tax terms – is substantial.

Prioritising repayment: a practical framework

Given this backdrop, here’s how to think about prioritising director’s loans:

Formal loans over £15,000: If your company has made formal loans to you exceeding £15,000 and they’re outstanding at the year-end, these should be your first priority. The Section 455 charge makes these extraordinarily expensive to maintain.

Director’s loan accounts (debit balances): If you owe the company money through a director’s loan account, the same Section 455 rules apply. If you’re in debit by more than £15,000 at year-end, you need to address this.

Below the £15,000 threshold: Loans below £15,000 escape the Section 455 charge, but they’re not cost-free. Any interest should be properly documented and recorded; otherwise, it may be challenged by HMRC.

Company debt to directors: Money the company owes you (as a director) doesn’t attract the Section 455 charge. However, you should ensure this is properly recorded in your director’s loan account. If the company later pays this back, it’s tax-free, provided the company can afford it from legitimate profits.

Practical next steps

Before deciding which loan to repay, run the numbers with your accountant. Calculate the exact amount outstanding for each loan as at the end of your last financial year-end. For any loan exceeding £15,000, ask your accountant whether the Section 455 charge has already been triggered – if so, you may be able to reclaim it by repaying the loan within nine months of the year-end (though this is time-sensitive).

Consider whether your company’s cash position allows you to repay all outstanding loans. If not, repaying the Section 455-triggering loans first minimises tax exposure. Also check whether any loans have formal interest agreements; if they do, ensure interest is being paid and recorded correctly.

Finally, going forward, avoid allowing significant loan balances to build up. If you need to extract money from the company, salary or dividends are usually cleaner from a tax perspective than loans.

For tailored advice, contact Severn Accounting — we’re here to help.