New business owners may find it hard to wrap their heads around that they cannot freely take cash from the company bank accounts for their own personal use, without first considering the tax and legal consequences. There is a separation between the business owners/directors and the company, the company in itself is its own separate legal entity. Only in very limited circumstances are directors allowed to borrow from the company under Irish company law.
Section 239 of the Companies Act 2014 sets out that a company may lend out a value of no more than 10% of its net assets to company directors or persons connected with a director. This is to protect the interest of all the stakeholders of the company such as its employees, suppliers, and shareholders.
From a tax perspective, a loan from a company to one of its directors may be classified as a preferential when the interest rate is too low. A preferential loan occurs when the interest charged on a loan to a director is below a specified rate which is set by the Department of Finance.
The current specified rates that have been laid down the the Department of Finance are:
- Qualifying home loans: 4%
- All other loans: 13.5%
If a director receives a loan from the company with an interest rate set below these specified rates, then the benefit of the reduced rate will be taxed as a benefit in kind. The benefit is treated as notional pay of the director for the relevant tax year. The director would then pay PAYE, USC and PRSI on this benefit received.
The criteria for the reduced specified rate for qualifying home loans of 4%, requires the loan to be for the purchase, repair, development or improvement of a principal private residence.
If the loan is ever written off by the company it will become taxable for the director in the year it is written off.
Greg Secker who is director and partial owner of a company called Long Stay Limited which operates a Hotel. The company had a bumper summer period due to an increase in tourists visiting the town and now the company bank balance is €150k. The company balance sheet is also in a healthy position, it has €500k of net assets.
Greg decides to take a loan of €20k from the company to buy a new car for his family. He agreed with the other directors that there would be no interest rate on this company loan. This loan complies with Irish company law as it is below 10% of the companies net assets.
The loan is however deemed a preferential loan as it has no interest rate that has been applied. Therefore to calculate the BIK on this preferential loan we will use a rate of 13.5% as it is not for a qualifying home loan.
Throughout the year there were no repayments made against the loan of €20k.
Notional pay of €2,700 is added to the directors salary and will be subject to PAYE, PRSI and USC. Greg already takes a salary from the company of €80,000 per annum, which means the additional €2,700 notional pay will be taxed at 52%. The tax then paid on this income will be €1,404.
Before you as a director decide to take a loan from the company you should consult with your accountant to discuss the potential legal and tax ramifications on yourself and also on the company. Company law can be a minefield and mistakes can be costly so it is best to proceed with caution and make sure everything is being done above board.
This blog post is for informational and educational purposes only and should not be construed as financial advice.