When you choose to set up a limited company, it is a separate legal entity to you as an individual. The money in your limited company bank account does not belong to you. This also means you benefit from limited liability, as you only risk what you put into the business.
However, as a company director, you can access funds in the business bank account through something called a director’s loan account (DLA).
This can be a useful facility if you need to fund a major personal purchase, such as a property deposit or unexpected car repairs. However, there are certain rules and tax implications to be aware of.
This article will cover exactly what a director’s loan entails, the guidelines to follow, and your tax obligations.
What is a director’s loan account?
Although the money in your limited company bank account doesn’t technically belong to you, you do have access to it through something called a director’s loan.
Essentially, HMRC defines a director’s loan as money taken from your company that isn’t either:
- A salary, dividend or expense repayment
- Money you’ve previously paid into or loaned the company
If you take money out for any other reason, the amount must be recorded in your personal DLA. At the end of your company’s financial year, depending on your activity, you’ll either owe the company money or the company will owe you money. This should be recorded as an asset or a liability in the balance sheet of your company’s annual accounts.
Director’s loans are used when you need to access the money in your limited company, other than what you take out as salary, dividend or business expense repayments. They can be used for when your personal finances need a boost, perhaps due to an unforeseen outlay.
Director’s loans can also be a useful tool to bridge the gap temporarily until company profits allow dividends to be paid out.
What should a director’s loan account contain?
Items you should record in your DLA are:
- Any cash withdrawals from the company that you’ve made as a director
- Personal expenses which were paid with company money or credit card
- Business expenses are any expenses that are incurred wholly, exclusively and necessarily in the performance of the duties of the employment. Anything that fails this test is, therefore, a personal expense.
- Cash withdrawals and repayments you make as a director
- Personal expenses paid with company money or a company credit card
- Interest charged on the loan
HMRC keeps a close eye to director’s loan accounts through annual company returns, so you need to ensure your records are complete and accurate.
Director’s loan account disclosure requirements
Depending on the borrowing repayment activity in your director’s loan account, at the end of your company’s financial year, either you will owe the company money, or the company will owe you money.
This should be recorded accordingly as an asset or a liability in the balance sheet of your company’s annual accounts. There is a requirement to disclose this in your annual accounts as a related party transaction.
Your DLA needs to contain evidence of all transactions involving your personal finances, as well as your company’s, to ensure it’ll stand up to scrutiny by HMRC.
This is a really risky area of running your own limited company, and for this reason, HMRC will keep your DLA under review through the company’s annual tax returns to ensure rules and guidelines are being followed.
Who can take a director’s loan?
As the name suggests, you need to be a director to take a loan from your company.
Why would you want to take a loan?
There are many reasons why you might need to take a loan from your company, for example covering a sudden repair bill for your car, or even paying for a holiday.
The important thing to remember is that the loan hasn’t been subject to either personal or company tax and HMRC is going to want what’s due.
When will I have to pay tax on a director’s loan?
If your DLA is overdrawn at the date of your company’s year-end, you may need to pay tax. If you pay back the entire director’s loan within nine months and one day of the company’s year-end, you won’t owe any tax. In other words, if your director loan account is overdrawn at your company year end of 30th April 2020, the loan must be paid back by 1st February 2021.
Any overdue payment of a director’s loan means your company will pay additional Corporation Tax at 32.5% on the amount outstanding. This extra 32.5% is repayable to the company by HMRC when the loan is repaid to the company by the director. There may be personal tax to pay at 32.5% of the loan amount if you do not repay your director’s loan. This is not repaid by HMRC when the loan is repaid.
The director will also need to declare the benefit on their personal tax return which will be subject to income tax at their applicable tax rate.
Do I need to record director’s loans?
Yes. It’s important that you understand your relationship with the company as legally separate – when you created your limited company, you established it as a legal entity. This means that it has its own statutory obligations and accountability and for this reason, everything taken out must be recorded.
What happens if I owe my company money?
If you owe your company over £10,000 (interest-free) at any given time, the loan is classed as a benefit in kind and you’ll need to record it on a P11D, as it’ll be liable to both personal and company tax. Your company will also need to pay Class 1A National Insurance at the 13.8% rate on the full amount.
If the company owes you money
Your company doesn’t pay any Corporation Tax on money you personally lend it and you can withdraw the full amount from the company at any time.
If you charge any interest, this will be classed as a business expense for your company and personal income for you. The interest amount must be declared as income on your Self Assessment and taxed accordingly.
Interest rates on director’s loans
If you lend money to your company or take a Director’s Loan from your company there are detailed rules about the timings of repayments and any interest charged or received. The Gov.uk site explains the various rates and rules you need to know – we recommend you speak to an accountant to ensure you don’t fall foul of HMRC.
‘Bed & Breakfasting’
The government introduced measures to stop directors managing their DLAs in a way that means they might avoid tax, known as bed & breakfasting.
This is a method sometimes used by directors to dodge tax by repaying their borrowed money to a company before the year-end to avoid penalties, only to immediately take it out again without any real intention of paying the loan back.
When a loan in excess of £10,000 is repaid by the director, no further loan over this amount can be withdrawn within 30 days. When this happens, the government’s view is that the director doesn’t intend to pay the money back and the full amount will automatically be taxed.
The ‘bed and breakfasting’ of a loan which falls outside of the 30-day rule, may still be subject to tax where the loan is in excess of £15,000. The rules state that where a loan of over £15,000 has been made to a director of the company, and before any repayment is made there is an intention to take a future loan of more than £5,000 which is not matched to another repayment, then the bed and breakfast rules apply.
So, if you make a repayment towards your director’s loan of more than £15,000 within 30 days, and intend to take a new loan of over £5,000 in the future, the ‘bed and breakfasting’ rules apply.
Of course, you might wonder how HMRC could possibly prove your intentions, but any patterns of repeated withdrawals or similar sums being withdrawn could be interpreted as an intention.
Given the complexity of these rules, we recommend you speak to one of our expert accountants about the most efficient way to repay a director’s loan.
If your company writes off a director’s loan, there are tax and accounting implications that need to be considered. We recommend you speak to an accountant to decide on the best course of action for you and your business.
Do HMRC monitor director’s loans?
Yes, they will also monitor DLAs which are regularly overdrawn. Be aware that they may decide that the money is not a loan but a salary, and subsequently charge Income Tax and National Insurance on the sum.
We suggest that you monitor your director’s withdrawals to ensure you don’t exceed the £10,000 threshold.
Our advice comes from our team of expert accountants but it’s always best to get specialist help from your accountant when dealing with things like director’s loans, so you know you’re always on top of the law and not liable for hefty fines.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert legal or other advice should be sought.