What is a Director’s Loan Account?
Taking a step back, it’s important to remember that a Limited company is a separate legal entity, completely distinct from the owners/Directors. This means that any transactions between the company and the Director’s should be recorded in the company’s accounts. It is this, which gives rise to a Director’s Loan Account.
So, a Director’s Loan Account is just a reflection of all the transactions between the company and the Director. Sometimes, the company may owe the Director money (a creditor in the company’s books) and sometimes the Director may owe the company money (a debtor in the company’s books).
Why does a Director’s loan account exist?
So, if a Director’s loan account is just a series of the transactions between a Director and the company – what sort of transactions are we talking about?
Well, the reality is that there can be a huge variety of transactions between the company and the Director which go against the loan account, some of which include:
- A loan from the Director to the company – perhaps to provide the company with cash when it first started trading, or to support it during challenging times.
- Company expenses paid for personally by the Director.
- Cash taken out of the company by the Director that does not relate to a salary or Dividend.
- Personal assets introduced by the Director to the company.
- Company assets transferred to the Director by the company.
- Director travel expenses using own vehicle that are not paid in cash by the company.
These are the types of transactions which bring a Director’s Loan Account into existence. The reality is that at any given time the loan account is likely to be made up of a combination of these past transactions. So, if a Director initially introduced £10,000 to the company when it first started and has since taken cash from the company of £4,000 the loan account will currently be showing a balance owed to the Director of £6,000. That’s why it’s crucial you record each and every transaction between the company and the Director, as we discover below.
Do I have to record a Director’s loan account?
The short answer is yes.
OK, so why do you have to record a Director’s loan account. Well, firstly, as you can see here it’s a legal requirement to record any money you borrow or pay into the company. But you should also want to record the transactions, because accurately recording them may increase the amount you can take out tax free in the future. Recording transactions with the Director is easy where the company has a good bookkeeping system in place.
For example, when you loan your company money, pay for company expenses personally, or undertake business travel in your own vehicle you are increasing your Director’s loan account, meaning the company owes you more money. This money can be repaid to you completely tax free in the future. So, if you don’t take the time to accurately record the transactions then you may be wasting £1,000’s every year in money which is rightfully yours.
Of course, there may also be times when your Director’s loan account is overdrawn meaning you owe the company money. It’s really important you’ve recorded all the transactions in this case, as there are tax considerations for overdrawn loans, which we’ll cover next.
What if I owe my company money?
As mentioned above, there will be times where you owe the company money. That’s not uncommon, and with the changes to the Companies Act 2006, an overdrawn Directors Loan Account isn’t illegal. However, there are a number of important considerations.
Tax on Director’s loan accounts
You may have to pay tax when your Director’s loan account is overdrawn at the date of the company’s year-end. This is the case unless you pay back the full loan balance within nine months and one day of the company’s yearend.
So, for a company with a 31 December year end, the loan must be repaid by 1 October the following year, otherwise a tax charge will arise.
Where the loan is not repaid, then it will give rise to a tax charge at 32.5% on the balance of the loan outstanding. So, for a Director with a loan of £50,000 that remains unpaid after 9 months a tax charge of £16,250 will occur and this is payable by the company to HMRC. It is important to note that this tax will be repaid to the company when the loan is repaid. However, this isn’t automatic and so you must remember to request the tax back from HMRC using form L2P. If you have an accountant, they will probably do this on your behalf.
So are there any other tax implications of overdrawn loans? Unfortunately yes, as we cover below.
Interest on Director’s loan accounts
Where you owe the company more than £10,000 the loan may give rise to a benefit in kind. This is only relevant where the loan is interest free. So, one way to avoid completing P11D’s is for the company to charge interest on the loan at the official rate. Where interest is charged this is taxable for the company, and also increases the Director’s loan balance.
Where no interest is charged on the loan, a benefit arises, and P11D forms are required for the cash equivalent of the amount of interest that should have been charged. The interest will be subject to company and personal tax as well at Class 1A National Insurance.
What if my company owes me money?
As we’ve already touched on, it’s not unusual for the company to owe the Director money. Where this is the case, you can withdraw the money completely tax free at any point.
It’s also worth noting the Director can charge the company a market rate of interest on the balance of the loan. This can be beneficial as it uses up the Director’s tax-free savings allowance (£1,000 for basic rate taxpayers/£500 for higher rate) and is tax deductible for the company. However, there are a few rules to follow including completing form CT61’s so this is best discussed with your accountant.
What is ‘Bed and Breakfasting’
Now we’re really getting into accounting and tax jargon. So, we promise we’ll keep this simple.
Bed and Breakfasting just describes some specific rules which are designed to stop Director’s ‘repaying’ overdrawn loans to avoid a tax charge, only to take out a new loan just a few days later. In this situation specific rules are likely to apply which means the tax charge will still arise on the full value of the overdrawn loan.
Summary
Hopefully that’s told you everything you need to know about Director’s loan accounts. We’ve covered what a Director’s loan account is, how it arises, the tax impacts, why you should record a Directors loan account and some specific rules for those trying to get around the tax charge.
If you have a question which we haven’t covered then by all means get in touch with us. Other useful resources for Director’s include:
- 2021/22 tax guide for business owners with 23 tax ideas to save you money this year.
- Thinking of getting an Electric car?
- Work from home? Consider having a rental agreement with your company
