Borrowing money from the company can make financial sense for directors, compared with using a commercial lender.
But using from the company bank account for personal expenditure has to be managed carefully, as complex tax and accounting rules apply. Failure to follow the rules can result in HMRC action against the director, such as disqualification.
What is a director’s loan account?
In a limited company, the business and its directors are separate legal entities. One of the practical implications of this rule is that the money in the company’s bank account does not belong to the directors.
However, while the funds do not belong to the directors, they are able to access the money through something called the directors’ loan account (DLA).
According to HMRC, the directors’ loan account is money taken out of the company bank account by a director that is not:
- Business expense repayment
- Money previously loaned or paid into the company by the director
Directors are allowed to loan money from the company bank account for any kind of personal use. This could be to pay for a holiday, a car, or a short term bridge loan until dividends can be paid out. In practice, the DLA is often used by directors to access funds until company profits allow for dividends to be drawn.
If a director withdraws money from the company bank account for any other reason, this has to be recorded in the DLA and accounted for in the company’s end of year tax return.
Only the directors of a limited company can use a directors loan account or take money from the company bank account for personal use, provided the activity is recorded on the DLA.
It is important to remember that the money taken as a loan from the company has not been subject to either personal or company tax, as such records are needed to ensure tax is paid on what is loaned.
HMRC uses companies’ annual returns to monitor DLA activity and check that the correct amount of tax is being paid in the correct way.
For example, if the director owes the company money, they will have to pay income tax on the amount taken through their self-assessment.
This means your accounts need to be maintained with complete records of all DLA activity and evidence of any transactions involving the directors’ personal finances, as well as the company’s to be fully compliant.
Loan accounts which are regularly overdrawn and in excess of £10,000 may attract scrutiny from HMRC. They may consider the amount not to be a loan, but rather salary and as such, subject to income tax and NI.
At the end of the company’s financial year, the DLA is totalled and will show as either the director owing the company money (asset), or the company owing the director money (liability).
This is then recorded on the company balance sheet of the annual accounts as a related party transaction.
What should a director’s loan account contain?
The DLA should provide a record of directors’ company bank account activity such as:
- Cash withdrawls and repayments made by a director from the company bank account
- All personal expenses paid for by the director using the company bank account or company credit card
- Any expenses that are not classed as business expenses
- Any interest chargeable on the loan
Directors’ loan account tax rules
If by the end of the company’s tax year you have taken more out of the DLA than you are owed, ie you are overdrawn, you will need to pay tax on the outstanding amount you have loaned.
If you pay the full outstanding amount back into the business within 9 months and 1 day of the company’s year-end, you will not be liable for tax on the amount that had been owed at the time of year-end.
For example, if your company’s year end is 31 May, you will need to repay the loan by 1st March the following year to avoid paying tax on what was owed.
Under the DLA rules, directors are able to take out up to £10,000 from the company as a loan for up to 21 months without incurring tax charges. Beyond this point, the loan will incur tax liability. For example, if the loan is taken on 1 June 2019, it will need to be repaid by 1 March 2021.
Any loan amount that remains outstanding on the date when the company’s corporation tax is due incurs a section 455 tax charge. Under section 455, corporation tax will be due at 32.5% on any amount of DLA that is outstanding on the trigger date, ie the corporation tax due date, or nine months and one day after the end of the company’s accounting period. This sum will be repayable to the company by HMRC when the loan is paid off by the director.
The director will also have to declare the outstanding loan on their personal tax return. This amount will then be subject to income tax at the relevant rate. This will not be repayable by HMRC.
If the director owes the company money
If the loan is over £10,000 at any given time, the loan is classed as a benefit in kind and must be recorded on the director’s P11D. It will be liable both to personal and company tax.
The company will also be liable for Class 1A National Insurance on the full amount, at 13.8%.
If the company owes the director money
If the company owes money to the director, there will be no corporation tax on the amount of the loan. The director can withdraw the money at any time.
If interest is being charged on the loan, it will be treated as a business expense for the company. The interest must also be declared on the director’s self-assessment return, and taxed as personal income.
Avoiding ‘Bed & Breakfasting’
In some cases, the director may look to repay the outstanding amount on the DLA before the trigger date to avoid the section 455 charge, and then reborrow the funds shortly afterwards.
However, ‘bed & breakfasting’ provisions introduced by the government mean this is no longer effective as a strategy to avoid tax.
There are two anti-avoidance rules directors will need to be aware of if considering reborrowing funds that have been repaid.
The first applies if the director repays £5,000 of the DLA, and within 30 days of the repayment date, reborrows a further £5,000 or more. The provisions consider that redrawing the funds in this way indicates the director had no intention of repaying the loan, and as such the repayment will be deemed ineffective. In this case, a section 455 tax charge will automatically be triggered on the lower of the amount repaid.
The second rule applies if the balance of the DLA is £15,000 or more immediately before the director makes a repayment, either in part or in full, but the director intends to, or has arranged, to reborrow from the DLA. This rule applies regardless of when the additional redraw takes place, even when outside of the 30 day period, as the repayment is considered to have been reimbursed by the new borrowing.
When considering the ‘intention’ of the director, HMRC may look at consider activity on the DLA, such as patterns of withdrawing similar sums as proof of the intention not to make the full repayment.
This is a complex area of tax, and directors should take professional advice to ensure they are maximising use of dividends for tax planning while avoiding triggering anti-avoidance rules.
For example, the anti-avoidance rule does not apply to funds taken as dividend or bonus or any other payment that’s taxable and this is used to repay part or all of a loan, although these will be subject to income tax.
Keeping DLA repayments and re-borrowings below £5,000 will also prevent triggering the 30-day rule.
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.