Director's loan accounts offer limited company directors a lot of freedom to both invest in their business and draw money from their business. Since the introduction of Real Time Information requiring up-to-date reporting on the payment of salaries, director’s loan accounts have become even more popular as directors use them to take “dividend-like payments” from their business on a regular basis – more on that later.
They are complicated to manage and, especially in cases when a company may be about to hit or has hit financial trouble, they can also present real dangers to a director’s personal finances.
What is a director’s loan account?
When you set up a limited company, the money contained in the business bank account is not yours – it belongs to your company. You can’t withdraw cash from your company in the same way that you can if you’re a sole trader.
If you lend your company money, your director’s loan account will be credited with the amount you lend it. If you take money out of your business, your director’s loan account will be debited with that amount. If you have lent more to your business than you have borrowed, your account is in credit. If the opposite is true, your director’s loan account is overdrawn.
If you want to take money out of your business which is not your salary, which is not a dividend payment, and which is not a repayment of a business expense, you take it out in the form of a loan from your company.
Perhaps the most popular use of a director’s loan account is to provide payments which are like dividends but which aren’t actually dividends. You can only pay yourself dividends from the profits your company makes after making allowance for corporation tax. A director may decide to borrow money from his or her company during a slow month and then repay them in a profitable month by issuing a dividend to the value of how much their director’s loan account is overdrawn – thereby bringing the account back to zero or to balance.
What records should you keep on your director’s loan account?
For your director’s loan account, you must record the money you take and pay back, any personal expenses you paid with company money or with a company credit card, and any interest charged on the loan. You may choose to charge the company interest if it owes you money and vice versa.
At the end of your company’s financial year, there are three potential situations with your director’s loan account:
- You don’t owe the company anything and the company doesn’t owe you anything
- Your company owes you money
- You owe your company money
If you owe the company money, it must be recorded in your business accounts as an asset. If the company owes you money, it must be recorded as a liability in your business account. Under current company law, this must be disclosed in your annual accounts.
Why are director’s loan accounts so useful?
They’re very flexible and relatively easy to administer. If you find yourself needing to make a payment personally but don’t have the funds, borrowing money from your company is much quicker and cheaper than approaching a bank or other financial institution.
When setting up a business, director’s loans (where you lend money to your new company) don’t attract tax when the company pays you back. If you lend your company £50,000 to start trading, you will receive £50,000 back when it repays you and no tax will be due on this amount.
When must I settle an outstanding amount on my director’s loan account?
You must settle any overdrawn director’s loan account within nine months of your company’s year-end or you will pay 32.5% corporation tax on it. You will be able to claim that back but it may take you years before you see the money.
If you pay a loan back to the business within that timescale, you are forbidden from taking out a loan again for 30 days. HMRC call this “bed and breakfasting” and will treat the original loan as never having been paid back therefore it will attract the 32.5% corporation tax charge.
If your director’s loan exceeds £10,000, it will be treated as a benefit in kind, your company will pay Employers’ National Insurance Class 1A on it (13.8% of the amount), and you’ll need to record it on a P11D form.
Director’s loan accounts – other tax considerations
If you take money from your business in the form of a loan or lend your business money, how much interest you decide to charge (or not charge) has implications for both personal and company taxation. This is quite a complicated area of tax and we would advise you to speak with your Financial Management Centre accountant partner for specific guidance relating to your situation.
Can you write off an overdrawn director’s loan account?
Yes, but it’s complicated. Attempts to write off an overdrawn director’s loan account nearly always occurs when a company hits financial problems (we cover this next). Always, always get advice from your Financial Management Centre accountant partner.
What happens to an overdrawn director’s loan account if my business becomes insolvent?
Because an overdrawn director’s account is an asset to a business (just like your invoices), an administrator may pursue you to repay your account if your company becomes insolvent. Creditors of your insolvent company may try to buy the right to pursue you for the full amount of your overdrawn director’s account to cover their losses.
What happens to my overdrawn director’s loan account if I die?
If you die while owing your company money, the company has the right to ask your estate to pay back the full amount of the overdrawn director’s loan account. This may leave your family in a perilous financial situation.
Help with all aspects of director’s loan accounts from the Financial Management Centre
For advice on all aspects of director’s loans, contact your Financial Management Centre partner on 0800 470 4820 or email [email protected]