Starting a new business is an exciting time for everyone involved, but it is very easy for new business owners to make the mistake of breaking company law when it comes to directors’ loans.
The directors and owners of small companies in Ireland are generally the same people and therefore feel like the company cash is essentially an extension of their own bank account.
Sole Trader vs Limited Company
When you operate a limited company you need to totally change your mindset, a limited company is a completely separate legal entity to you (it’s like a separate person).
The money sitting in the company bank account is not owned by you, it is the company’s property.
When individuals start a company with no prior knowledge this can be very confusing, it can be hard to fight the temptation to withdraw the cash and use it for their own personal expenses.
This is quite different to someone who is a sole trader, where there is no legal separation between the owners and the business. Sole traders can take cash generated by the business (commonly referred to as ‘Drawings’) and use them without facing any legal or tax consequences. Furthermore, they do not owe this money back to the business like a director/owner of a limited company.
When the owners of a business what to access some of the wealth generated by the limited company they created they must follow certain procedures.
Loans to Directors Rules Explained
Under Irish company law, a director can draw down loans from the company up to a level of 10% of the company’s net assets without going through a Summary Approval Procedure (SAP).
If the director has borrowed in excess of 10% of the company’s net assets without Summary Approval then they are in breach of the Companies Act 2014.
The net assets of the company are equal to its Non-Current Assets + Current Assets – Current Liabilities – Non-Current Liabilities. This will also equal the Equity section of the company Balance Sheet.
Such breaches can lead to prosecution by the OCED (Office of the Director of Corporate Enforcement), someone you don’t want to be messing with when you are new to business.
Time may still be on your side if you are in breach of the 10% of net assets rule, the company will have 2 months to make arrangements to reduce directors’ loans which have broken the limits set out by company law from the time that it is discovered ( or ought to have been discovered in reasonable circumstances).
There are no such problems in the opposite scenario when the director is owed money by the company i.e a company debtor once the appropriate records are kept.
Where the terms of any transaction or arrangement by a director to the company or the holding company are not set out clearly in writing or are ambiguous as to whether the arrangement constitutes a loan or quasi-loan, then it is presumed that the transaction constitutes neither a loan or a quasi-loan and instead constitutes a gift or capital contribution.Source: https://www.grantthornton.ie/globalassets/1.-member-firms/northern-ireland/insights/factsheets/grant-thornton—companies-act—directors-loans-and-advances.pdf
How Can Owners/Directors Access Company Cash
There are a number of ways that company owners/directors can access the cash of a company that does cause any legal issues for the directors of the company.
- Payment for services performed:
- Reimbursement for business expenses
- Directors loans up to 10% of net assets
Each of these will have their own specific tax consequences however, you should contact your accountant to make sure to use the most tax-efficient method.
Summary Approval Procedure
There are scenarios where the director of a company can borrow more than 10% of the net assets of the company under the Companies Act 2014 using the Summary Approval Procedure.
But be careful, using the Summary Approval Procedure can result in all company directors being exposed to unlimited personal liability when it comes to the company’s debts.
Here is what you need to do to successfully use the Summary Approval Procedure:
- Declaration must be made with the CRO within 21 days of the loan being made
- Board members must pass a special resolution within the 12 months leading to the loan
- A declaration must be made by the majority of the board members no more than 30 days before step 2. The declaration must contain details such as; nature of the arrangement, purpose, details of director the loan is made out to, inquiry into whether the loan will affect the ability of the company to pay its debts, etc.
Another situation where a director can find themselves personally liable for a company’s debts is in a situation when the company cannot pay all of its debts during liquidation and where it is assessed in a court the director’s loans have contributed to this inability of the company to repay its debts.
Not only does the company have to worry about its loans with its directors but it will also need to keep a close eye on any breaches due to loans with connected parties of directors.
Connected parties include:
- that director’s spouse, civil partner, parent, brother, sister or child
- a company shall also be connected with a director of a company if it is controlled by that director or by another body corporate that is controlled by that director.
- a person in partnership with the director.
Tax Complications of Director’s Loans
Loans made to directors that do not bear interest are deemed to be preferential loans. In such cases, a BIK calculation is required on the interest foregone and the director will have to pay PAYE, PRSI and USC on the Benefit in Kind.
Another tax implication is that if there are outstanding directors’ loans at the end of the year the company may be faced with an income tax charge on outstanding balances. This can be reclaimed by the company if the director repays the loans within the space of 4 years.
Disclaimer: This blog post is for informational and educational purposes only and should not be construed as financial advice.