Funding a business with a Directors Loan rather than with Equity

Funding a business with a Directors Loan rather...

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 The company was formed with just £1,000 equity with the sole purpose of then buying the assets of a going concern for £50,000, the funding for this was provided by the directors (husband and wife).

I feel that it would be advantageous for this to be recognised as a directors loan so it could be drawn down as cashflow allows without any PAYE or NICs liability.

Is this allowed (and the best approach) or must they recognising the £50,000 as an additional equity investment and recover it through dividends?

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Euan's picture
By Euan MacLennan
09th Feb 2010 10:35

Oh! Dear!

Why lock up £1,000 of share capital when they could have issued just 2 shares at £1 each to the husband and wife?

Of course, the company's expenditure can be funded by loans from the directors (or anyone else) which can then be repaid without tax consequences when the company's funds permit.  If the directors have borrowed money to fund their £50,000 loan to the company, they can claim tax relief on the interest paid on their personal tax returns.

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Giraffe
By Luke
09th Feb 2010 11:05

It seems to be a fairly common misconception now that £1,000 is

I have had a few new clients come to me recently who have all got £1,000 share capital, all one man band companies or H&W combinations.

When asked why they have £1,000 share capital they have all been saying they thought it was the minimum allowed.  I think in most cases they have formed online themselves or bought a ready made company.

I must admit I often go for £10 so that it can be divided in 10% shares or occasionally £100 if I know it is likely to be split further in the near future but £1,000 seems just to be a waste.

As for the company being funded via a director's loan, Euan is of course right, it is entirely normal for start ups to be funded via a director's loan.

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Replying to cheekychappy:
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By james3
31st Jul 2014 01:12

They could

Luke wrote:

I have had a few new clients come to me recently who have all got £1,000 share capital, all one man band companies or H&W combinations.

When asked why they have £1,000 share capital they have all been saying they thought it was the minimum allowed.  I think in most cases they have formed online themselves or bought a ready made company.

I must admit I often go for £10 so that it can be divided in 10% shares or occasionally £100 if I know it is likely to be split further in the near future but £1,000 seems just to be a waste.

As for the company being funded via a director's loan, Euan is of course right, it is entirely normal for start ups to be funded via a director's loan.

They could just do 1000 5p shares and allow division to 0.1% for only £50 (or something similar).

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By sluglet
10th Feb 2010 11:59

Creditors: Amounts Due After More Than One Year

Euan is of course right there's no problem tax wise with putting in a directors loan of £50k. This may leave the balance sheet looking overdrawn which could be a problem though if you want to raise finance as some/most bank managers don't really understand accounts also anybody looking at the abbreviated accounts at Companies House might think the company is a poor credit risk.  A simple way round the problem is to get the client to give you a letter, which you could even draft for them, saying that (for example) £40k of the loan is repayable after more than one year. You can then legitimately move the loan into the creditors due >1 year and improve appearance of the balance sheet.

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By nogammonsinanundoubledgame
10th Feb 2010 12:50

We did have a case recently ...

... when the directors regretted going down the director's loan route.

The obvious nightmare happened: company went down the pan, and the director's loan account was irrecoverable.

They now have a nice healthy CGT loss that they have no prospect of relieving any time soon (and then would be at 18% or so), whereas had they put it all in by way of share capital they could claim an immediate IT loss at 40%.

With kind regards

Clint Westwood

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By tax adviser
10th Feb 2010 12:53

Why shy away from the commitment?

Folks,

Is there any H & W company which can function with less than £1,000 committed capital? If not, why do we advisers encourage the perception that £2 committed capital is enough? I know that the legal minimum is £1 but is it sufficient and prudent to expose the general public to the risks of doing business with a company whose owners have only committed a pound to it?

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Replying to tax adviser:
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By mominnz
21st Feb 2019 02:24

The best and most accurate answer.

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Replying to mominnz:
By JCresswellTax
21st Feb 2019 09:36

9 years later, you're sharp!

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By SimonLever
10th Feb 2010 12:57

Don't forget....

"...buying the assets of a going concern for £50,000..."

This is effectively a sale of a business to a connected party so don't forget the capital gains side of things from the directors' point of view and that the value has to be at market vale for the sale.

 

 

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By User deleted
10th Feb 2010 12:59

Where

does it say that the going concern is being acquired from a connected party?

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By Marlowe52
10th Feb 2010 13:07

A bit more detail for anyone who needs it...

I have to own up to not being a qualified accountant - But I do run my own 'husband and wife' business and use Sage Accounting to do all company accounts and returns (and have been doing so for years).  This was a steep learning curve for me - but a very rewarding one.  Perhaps the most difficult concept at the outset was the operation of the Director's Loan Acount.  Essentially, you can operate a single Director's Loan Account (which I will call DLA1) in the Nominal ledger.  To this you might post as debits:

(a) All Interim Dividend Payments (i.e. cash withdrawn from the company in anticipation of dividends)

Then as credits:

(b) Net salary payments to the Directors

(c) Actual Dividend Payments

(d) Authorised Expenses (debited against Director's Expense Accounts when approved)

etc.

This means that the Director's Loan Account keeps a running total of money owed by the Directors to the company (debit balance) or money owed by the company to the Directors (credit balance) 

You could, therefore simply deposit your £50,000 in the company bank account - debit the Bank account and credit the Director's Loan Account...   Simples!

OR given that you might want to calculate interest which the company could legitimately pay the Director's for borrowing their money (this must be at demonstrably commercial rates!)  I would personally hold the £50,000 in a separate Director's Loan Account (DLA2) to which interest could be added.  Then if a debit balance arises on DLA1 (i.e. you've drawn money out of the company) simply reduce DLA2 by posting a debit to DLA2 (reducing the loan) and a credit to DLA1 - Maybe not so simple - but effective.  The Directors would only pay tax on dividends and any non-allowable expenses drawn from DL1.

I apologise this is telling many readers how to suck eggs - but for us non-accountant bookeepers it was not obvious to me how this worked at first!!

Regards 

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By User deleted
10th Feb 2010 16:58

oh dear indeed !

Complicated these limited company thingys !

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By Malcolm Veall
11th Feb 2010 10:13

Dividends or not?

Marlowe52,

Be careful with the description on your entries.  You do not have interim dividends and actual dividends.

The amounts drawn in the year are either drawn against director's loan account, or they are interim dividends, (which are every bit as "actual" as final dividends).  An interim divdiend is taxed on the shareholder on the date it is drawn and, in a sense, does not need to go anywhere near the DLA - Debit dividend Credit bank.  Amounts drawn against DLA are debits there and there may be credits to the DLA at another date for dividends declared, which are taxed on the directors and Credited to the DLA on the date they are declared.

Do not leave this as something to be sorted out by the year-end/tax accountant - HMRC take the description of the entry in the books, (Sage in your case), as important in determining what the directors intended.

 

There are lots of threads on AWeb on this topic - although the extensive discussions there may confuse as much as help, the law in this area is not straight forward.

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By User deleted
11th Feb 2010 10:23

basics

The best way of learning these basics of company law, accounts and tax would be to go on an Accountancy course.

Most of the above comments indicate a severe lack of knowledge in this area.

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By Malcolm Veall
11th Feb 2010 10:33

Which comments?

Anonymous 10:23

As a matter of interest do you mean the thread generally or my comments, which are "above" yours?

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By Marlowe52
15th Feb 2010 11:45

Many Thanks

Many thanks for the very valuable advice and caution on my posting.  I hurridly checked and was relieved to find the drawings from the Directors Loan Account have been posted as exactly that!....

 

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By HERDAL
09th Jul 2015 08:09

Loan to company in return for shares

HI

One of the shareholders invested in the limited company and got shares in the company in return, however, this loan have been paid back by the company with interest to that shareholder, can the share holder do this? please comment

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