Loans between companies and their directors, shareholders or employees are a common feature of business life. Whether used to manage short-term cash flow or meet a personal financial need, these arrangements can seem straightforward.

However, director and shareholder loans can carry significant company law and tax implications. From restrictions on how much a company can lend to potential income tax liabilities and benefit-in-kind (BIK) charges, overlooking the rules can result in unexpected costs, interest and penalties.

So, what should companies and their advisers be aware of?

1. Company Law: How Much Can You Lend?

Company law places restrictions on loans made to directors and people connected with them.

Generally, the amount a company can lend is limited to 10% of its net assets, based on the last set of financial statements laid before the members at the AGM. If no financial statements have been prepared, the limit applies to the company’s called-up share capital instead.

Importantly, this is not a once-off calculation. If a company’s net assets decrease, its permitted lending amount may also fall. Where the applicable limit is breached, the excess must be repaid within two months.

Failure to comply can result in civil and criminal penalties, making regular monitoring of director loans an important part of good financial management.

2. Close Companies: The Tax Cost of Loans to Shareholders

Additional tax rules apply when a close company lends money to a shareholder (known as a participator) or an associate of a participator.

In these circumstances, the company may be liable to pay income tax on the grossed-up loan amount at the standard rate, currently 20%. This tax is generally recoverable where the loan is subsequently repaid, subject to the relevant conditions and a claim being made within the applicable four-year time limit. No interest is paid on the refund.

Certain exceptions may apply. For example, loans made in the ordinary course of a company’s money-lending business can be excluded. There is also a potential exemption for qualifying loans to full-time directors or employees, provided the total relevant loans to the borrower and their spouse do not exceed €19,050 and the borrower has no material interest in the company or an associated company.

What happens if the loan is written off?

This is where the tax consequences can become particularly costly. If a loan to a participator is forgiven:

• The company generally cannot recover the tax paid on the original loan.
• The amount forgiven is assessed as income for the participator in the year of forgiveness, using the applicable gross-up rules and allowing credit for the tax withheld by the company.
• The write-off is not deductible against the company’s trading profits.

A decision to waive a shareholder loan should therefore never be taken without considering the tax implications for both parties.

3. Benefit-in-Kind: Are You Charging Enough Interest?

Loans to directors and employees can also trigger benefit-in-kind obligations where the interest charged is below the applicable preferential loan rate under Section 122 of the Taxes Consolidation Act 1997.

The relevant rates are:

• 4% for qualifying loans used to purchase, repair or improve a principal private residence.
• 13.5% for other loans.

Where a BIK arises, the taxable benefit must be calculated and included in the relevant payroll reporting. This obligation can apply even where the loan itself is permitted under company law and no tax charge arises under the close company loan rules.

4. Take a Proactive Approach to Loan Compliance

Director, shareholder and employee loans should not be treated as routine bookkeeping entries. Their treatment can depend on the company’s financial position, the borrower’s employment status, the purpose of the loan and whether repayments are made.

Regular reviews can help identify potential issues early, ensure payroll and tax reporting are correct, and reduce the risk of unexpected liabilities.

Read more: Five financial decisions to make before year-end