What is a Director’s Loan Account?
Running a limited company usually involves trying to deal with and understand legislations. One of these tax legislations are DLAs or director’s loan accounts.
This guide aims to walk you through DLAs and help you fully understand what they are, know about obligatory taxes to pay, and important guidelines to keep in mind. At the end of this article, you’ll find yourself with an extra ounce of knowledge on director’s loan accounts.
What are director’s loan accounts?
Your limited company has a bank account with funds that do not actually belong to you but are accessible through what we call a director’s loan.
A director’s loan, as defined by HMRC, is money withdrawn from a limited company that does not count as a salary, dividend or expense repayment. Neither is it money that you deposited as payment to the company nor money that the company owes you.
When you withdraw, for any reason, money from your company’s bank account, you must make sure that the amount is accounted for in your personal DLA. When the financial year ends, the withdrawal will be reflected in the balance sheet, either as an asset or a liability, depending on whether you still owe the company money, or the other way around where the company owes you money.
What should a director’s loan account contain?
Your director’s loan account must record:
- all cash that you’ve withdrawn from the company as company director
- personal expenses that you paid using company funds or the company credit card
This means that all personal expenses must be recorded in the DLA. Expenses that are not used solely for business or employment purposes are considered personal expenses.
Apart from accounting all personal expenses in the DLA, you must also be able to attach proof of transactions, yours and the company’s, to pass reviews made by HMRC. HMRC can check for discrepancies or whether or not you follow the rules and guidelines by simply looking at the annual tax returns of your company.
Who is allowed to take a director’s loan?
In order to take a loan from your company, then you must be seated as director.
Why do company director’s take a loan?
A director may have different possible reasons for taking a loan from the company. Such reasons may include the need to pay emergency expenses, or perhaps, expenses incurred during a trip.
Whatever the reason, it is important to make sure that the loan is not subjected to both personal and company tax. Also, a loan is a loan that must be paid. HMRC would want to see the loan settled in the company’s accounts.
When will tax be paid on a director’s loan?
If the director’s loan account is overdrawn at the end of the company’s financial year, the director may need to pay tax. If the loan is paid back nine months and one day after the company’s year-end, then no tax is owed. For instance, the end of the company’s financial year is 30th April 2020. This means that the director will have until February 2021 to fully pay the overdrawn loan.
In the case of an overdue payment, the company is subject to a 32.5% additional Corporation Tax on the outstanding balance. HMRC may return this 32.5% tax to the company once the director has settled the remaining amount. If the director fails to pay the loan amount, then he is also subject to a 32.5% personal tax, not anymore repayable by HMRC even if he fully pays his loan.
When taking a director’s loan, the benefit must be reflected on the director’s personal tax return, and an income tax, based on the corresponding tax rate, will be deducted.
Is there a need record director’s loans?
Yes. Even if you are director of your limited company, by law, your company is a separate legal entity with its own accountability and statutory obligations. In other words, you and your company are legally separate, therefore, anything taken from the company must be accounted.
What happens if the director owes his company money?
If the loan amount exceeds £10,000 (interest-free), it will be referred to as a benefit in kind. Benefits in kind are subject to personal and company tax and must, therefore, be recorded on a P11D. Apart from taxes, the company is also required to pay National Insurance (Class 1A) with a 13.8% rate on the full loan amount.
What happens if the company owes the director money?
If the director personally lends money to the company, the company is not required to pay any Corporation Tax. Also, the director can, at any time, withdraw the amount owed in full.
If the director charges an interest, the loan will be recorded as a business expense on the company’s side, and as personal income on his side. The interest amount is subject to tax, so it is important to make sure that it is declared as income in the director’s Self-Assessment.
Interest Rates on Director’s Loans
There are guidelines to follow when taking a loan from a company, or when lending the company money. These rules and guidelines, which discuss the applicable interest rates and repayment schedules, are available in the Gov.uk website. Speaking to an accountant to make sure one understands his obligations when it comes to director’s loans is recommended to avoid any issues with HMRC.
“Bed and Breakfasting”
Bed and breakfasting is a term coined to describe some directors’ practices where they try to avoid taxes on a director’s loan account. Fortunately, the government has found a way to intercept such practices.
When bed and breakfasting, a director will simply repay the loan amount before the end of the company’s financial year, making the loan totally free from taxes due. After this repayment, and upon renewal of the financial year, the director takes out another loan, for the same or higher amount, this time without plans of paying it back.
With the bed and breakfasting rules, when a director repays a loan in excess of £10,000, he is not allowed to take out another loan within 30 days. If the director does not make a repayment, then the full loan amount will be subject to taxes.
There are applicable taxes if a loan that exceeds £15,000 is taken out beyond the 30-day limit. According to the bed and breakfasting rule, if a director takes out a loan exceeding £15,000, and intends to take out another loan that goes over £5,000 before paying for the first loan, then the bed and breakfast rules apply. This means that the bed and breakfast rules become applicable even if the director repays his initial loan of £15,000 within 30 days, but shows intentions of applying for another loan exceeding £5,000.
HMRC reviews withdrawals and if they see any pattern, especially with the withdrawal amounts, they may flag these transactions as a possible “intention”.
Again, to better understand the bed and breakfast rules, it is best to speak to an accountant and seek advice on how to manage DLAs.
Before a company decides to write off a director’s loan, it is important to consult with an accountant to make sure all tax and accounting implications have been considered.
Does HMRC monitor director’s loans?
Yes. HMRC also monitors director’s loan accounts that are always overdrawn. Since HMRC may mistake these loans as salary and have these subjected to Income Tax and National Insurance, it is recommended to always make sure that withdrawals do not go in excess of the £10,000 limit.
A Director’s Responsibilities
Our detailed guide on a company director’s responsibilities will help directors understand the scope of their duties when it comes to running their business and give them tips on how to ensure a successful business operation.