You are probably aware that back in July last year, the government announced a major shake-up in the way that dividends are taxed from April 2016. This change will significantly raise the burden of tax on many small business owners operating within limited companies. The question you may not have been asking however is:
How have these changes affected the value of my director’s loan account?
Before we launch into this, please note that all of the below assumes a very simple set of circumstances (where the only income is through dividends, and a tax-efficient director’s salary). For more complex circumstances, with other sources of income, the same idea applies but the numbers will change.
Prior to the changes in dividend tax rates, you could only make savings through the use of your director’s loan account where drawings exceeded £29,000 each year. In order to demonstrate this, I am afraid that we will have to make a brief detour through some accountancy and maths-speak (so please bear with me!):
Without a director’s loan account, in simple circumstances, you would be paying an effective tax rate of 25% (note: this is the actual tax suffered, after taking into account any dividend tax credits and allowances) on all drawings over £29,000 from your company (plus of course your tax-efficient £10,000 director’s salary). This means that, under these rules, a director’s loan account of £200,000 utilised tax efficiently would result in total savings of £50,000 (I have made the assumption here that drawings in the company are kept under £100,000 per year).
Now, believe it or not, for those of you still with a director’s loan account, the recent changes have yielded some good news. When the effective tax rate on your dividend increases, the value of your director’s loan account also increases, resulting in opportunities for some nice tax savings. Again, bear with me as I delve back into some practical figures (unfortunately, the changes have made the calculations slightly more complicated, and so I have had to run a few specific situations to illustrate potential values):
-
Drawing £48,000 per year (with no other income)
-
After taking into account the personal allowance and tax-free dividend allowance, this will result in £32,000 taxable dividends per year, with tax on this of £2,400 incurred.
-
Drawing down on your director’s loan account would, therefore, save you £2,400 in tax per year. On a director’s loan account of £200,000, this would result in a total saving of £15,000 with the loan account being depleted in the 7th year.
-
Drawing £80,000 per year (with no other income)
-
Again, after taking into account the personal allowance and tax-free dividend allowance, this will result in £64,000 taxable dividends per year, with tax on this at £12,800 incurred (£10,400 of this being higher rate tax). Drawing down on your director’s loan account, therefore, would save you £12,800 p.a. On a director’s loan account of £200,000, this would result in a total saving of £38,400 with the loan account being depleted in the 4th year.
As you can see, there can be many different results dependent on your level of drawings, but one thing remains the same – your director’s loan account is now worth much more thanks to the changes in early April.
If you have any questions about getting the most from your director’s loan account, please call 01872 300232 or email us at hello@hivebusiness.co.uk.
