How a Directors’ Loan Account works and where tax comes in

The term Director’s Loan Account is the name used to cover money a director of a limited company takes out of the business for any other reason than as a salary, dividend or repayment of money they have put in.

The term reflects the fact that if you do this, you are borrowing money from the business and you owe it back. It’s perfectly legal, provided the business isn’t in financial difficulty and that the company articles allow for it. It is, however, very important to understand exactly how the account works in order to avoid confusing personal and business cash or becoming tangled up in tax complications.

Working with a Director’s Loan Account

Typically, a director will have what is known as a ‘current account’ with the company. This will be credited whenever the business owes the director for something such as expenses incurred on company business. When a director wants to take a loan from the business, a directors’ loan account should also be set up. This can be kept separate from the current account for bookkeeping purposes, or the two can be merged into a single account that includes all director/business transactions. The benefit of choosing the single account option is that you get a single figure showing at a glance how much of your money is tied up in the business or how much you owe to the business.

If the account is in credit, then that figure shows an amount of money you are effectively lending the company, reflecting the fact you have put more money into the business than you have taken out. This money is yours, and you can take it out as and when you wish. There are no tax implications. If you decide to charge the business interest on the money, however, you do of course have to declare this for income tax purposes.

If the account is in debit, then the account is overdrawn and you owe the business money: you have taken out more money than you have put in. This does bring tax implications, which I’ll come to shortly.

Even if no account is set up in your company’s books, HMRC will still consider any money you draw out as a director’s loan. If they undertake an enquiry, they will expect to see a full transaction history of director’s loan arrangements.

If your business has more than one director, you must keep records of each loan account separately, and any personal spending using company money must be recorded in the appropriate account.

Shareholder/Board approval

Loans of more than £10,000 are subject to shareholder approval. This is usually provided via an Ordinary Resolution and should be documented. The terms of the loan should be agreed by the Board and should also be documented.

How to repay the loan

You can repay the loan by:

  • Putting money directly into the business bank account.
  • Offsetting the amount borrowed by raising a non-payable dividend.
  • Offsetting the amount borrowed by crediting the account with sums spent using your personal cash on behalf of the business – e.g. reclaiming expenses.

Tax implications of a Directors Loan

  1. Corporation tax

HMRC can levy a tax charge called S455 if there is still a balance outstanding in the director’s loan account by the date of the company’s financial year-end and where the company is a close company – typically a business with less than five shareholders or directors. The sum owing is 25% of the balance due at the period end, and it is payable at the latest nine months and a day from that point. The idea is to deter companies from providing directors with what is effectively a generous perk – an interest free loan.

The good news is that as soon as the director does pay back the loan, the business can reclaim the tax paid. If the director pays up before the nine months and a day deadline, then the tax never needs paying in the first place.

  1. Benefits in kind

If the loan is greater than £10,000 and no interest is being charged, HMRC expects to see an amount equal to the cost of the interest reported on form P11D as a benefit in kind. The business also has to pay Class 1A NICs on the amount, and the director has to pay income tax on it. It can work out cheaper and easier to charge the director interest in the first place.

If you do want to take cash out of the business for personal use, therefore, be aware that the tax situation may not be straightforward and that you need to make sure your reporting is compliant. It’s important to make arrangements as early as possible, particularly in light of today’s RTI reporting requirements.

If your accountant hasn’t talked to you about how to make best use of your Director’s Loan Account, we’d be happy to help. Just email me here or give us a call on 01625 869712

 

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