Did you know it's possible as the director of a limited company to:
This is all achieved through the director's loan account and can be particularly useful in emergencies where payments may need to be made immediately, or if your business needs access to quick funds.
In this blog we explain what the director's loan account is, how it works, and the implications and risks of borrowing money from, or lending money to, your company. You'll then have a good feel for when to make use of this financial mechanism and the tax considerations involved.
This post covers:
A director's loan is money taken out of a limited company that isn't classified as dividends, salary, or expenses. As the director, it's money that you are borrowing from the company, so you will subsequently have to settle the debt. The other form of a director's loan is where you lend money to your company.
The director's loan account (DLA) only applies to a limited company and is a record of the transactions between the company and its directors. It details either, the money borrowed by directors from the company, or the money lent by the directors to the company.
The loan account can also include other transactions between the company and directors including the payment of expenses and the purchase of assets.
You may need to borrow from your company to cover the payment of bills, or unexpected expenses. Given the potential tax penalties and complications of this arrangement, this is something that should be considered in emergency scenarios only, a case of waiting for the payroll run, or dividend pay out won't suffice for the payment timelines in question.
Alternatively, you may lend your company money to potentially ease cash flow difficulties, or to help with initial set up costs in the early days of starting out. Doing this means you, as the director, become a creditor of the company.
A record of all transactions between directors, and their companies, is important because it provides evidence of these dealings. This can then help with financial planning and business budgeting. If all transactions are properly accounted for, then that will help ensure compliance with UK tax legislation and prevent against potential conflicts of interest between the company and its directors.
A limited company is seen as a separate legal entity to you as the director and shareholder. This means any profits generated through business activities belong to the company. That money can only then be extracted when it's declared as dividends, or run through the payroll in the form of salary.
If, as a director, you take money out of the company prior to declaring dividends, or operating the payroll, this will be seen in accounting, and legal terms, as a loan from the company to you. In the same situation, any money that you put into the company, that you don't already owe it, would be viewed as a loan from you to the company.
If you've conducted director's loan account transactions then this means any money declared through dividends, or payroll, is run against the loan account to offset against any money that you already owe.
If you were to take £1,000 from the business account, and there's sufficient money in the business bank account to do this in the form of profits after the deduction of corporation tax, then you'd owe the company £1,000 given payroll hasn't been run, and dividends not declared.
When you do run the payroll, say at the end of the month, if we assume a salary of £12,000 then the payment could be £500, and similar to a bank balance, this would leave the account overdrawn by £500. Then, when you get to the end of the quarter, and having reviewed your management accounts, assuming there's sufficient money in the business bank account, you may then declare £15,000 of dividends!
This must be posted to your director's loan account, which is £14,500 in credit given the £500 has already been offset from the money you'd taken out. A remaining £14,500 could then be declared to you, and subsequently taken out of the company. The point here is the dividends you declare, versus the money you withdraw from the company, aren't necessarily the same amount.
The tax implications of a director's loan account can be complex and are dependent on the financial position of you as the director, and your company. It's advisable therefore to obtain professional advice to plan and tailor any tax strategies to your circumstances. As a general rule, the below tax scenarios, and implications, are applicable.
Remember, as a director, you get taxed on the amount of money declared to you through your dividend. As the example earlier demonstrated, that can be different to the amount you physically draw out. So, you will end up owing the taxman whether you withdraw that exact sum of money from the company, or not.
Attempting to avoid tax by not declaring dividends and payroll whilst taking loans from the company isn't really an option from a tax perspective. It's true that the director's loan account can be a short-term tax-free perk, but this is conditional on it not going above £10,000 for the year, plus an overdrawn account must be rapid within 9 months of your company's year end.
So, whilst there isn't a limit to how much you can borrow from your company, financially there will only be so much it can viably extend to you. Go above £10,000 and the loan is treated as a benefit-in-kind to be reported in your tax return.
It is possible that you could accidentally pay yourself through dividends but without sufficient profits in the business with which to make the payment from. Such an issue can happen if your management accounts have been prepared in error meaning the dividend is declared by mistake.
The result is an illegal dividend which is then converted to a director's loan in the DLA meaning you have 9 months in which to make repayment.
It is at the discretion of your company how much interest it charged on a director's loan.
However, be warned, if this rate is below HMRC's official rate then the discount to you as the director could be treated as a benefit-in-kind, resulting in a tax charge on the difference.
You have 9 months to make full repayment of a director's loan. Fail to do this and you are then charged corporation tax on the unpaid amount. This works whereby section 455 tax is applicable and payable at 32.5%, a significant tax bill.
Should you clear the director's loan account then the section 455 tax is in fact refundable, albeit this is a time-consuming process being 9 months after the end of the accounting period in which you cleared your debt.
It is therefore preferable not to let this happen and it could be potentially more sensible to pay your director's loan before settling your corporation tax liability. Remember the payment deadline for corporation tax is 9 months after your accounting year end which provides you with a window of time.
There are some loans that are, in fact, excluded from the section 455 tax charge. These are loans to directors who don't have a 'material interest' in the company, meaning they don't own shares.
These loans are excluded if they are made to a director, or employee, of a limited company (or of its associated company) so long as the following conditions apply:
As a rule, a director or employee is generally treated as working full-time in a company if their hours are at least three-quarters of the company’s normal working hours.
If you have taken out a director's loan than you have to wait for at least 30 days from repaying one loan to then taking out another.
This legislation means you can't avoid the corporation tax penalty for late repayment by paying off a loan through more borrowing.
You may lend money to your company to fund various activities on a short-term basis. The interest on the loan is treated as taxable income for you that you have to declare in your tax return.
For your company the interest is a business expense, and it can then claim tax relief on the interest paid.
As all the above demonstrates, it's very important to keep accurate and detailed records. Tax advice and decisions need to be taken in light of people's circumstances and how decisions in one area can impact on planning in another. So, it pays to take advice from a good small business accountant.
The content of this post was created on 21/06/2023.
Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.
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