For entrepreneurial individuals who have chosen to set up a limited company, then you may find that the director’s loan account (DLA) can be a difficult concept to understand.

Unlike in cases of partnerships and sole traders when taking money out of the business is generally a straight-forward procedure without any tax implications, taking money from a limited company is a different matter entirely, as the company is considered as a detached legal entity.

It’s worth noting that the director’s loan account isn’t a real bank account – while the company may have a business bank account, it is a separate thing to the director’s account.

Rather, the director’s account is a virtual account that only exists within the accounting records as a way of keeping track of the flow of money between the limited company, and the director as an individual.

Because the money made by a limited company belongs to the company, and not to the director personally, taking money out, and putting money in can be complicated.

Putting money in and taking money out

There may be times when you begin to worry about the state of the company cash flow, and feel it needs assistance from your personal funds in the early days of running the business.

By putting money into the company bank account, you’re making a loan to the business, which means that you will also be owed that money back into the director’s account. You don’t necessarily have to be putting money into a company bank account in order to make a loan to the business.

If you’ve bought items for the functioning of the business out of your own money, then the value of those items would need to be recorded in the director’s account as money that is owed to you.

The important thing to keep in mind is that you can take the money you put into the company back at any time. You can access money via wages, dividends, or as a cash repayment of a loan that you have previously made.

However, if money is removed from the company that isn’t a dividend, wage, or loan repayment, then you will be using a “director’s loan” to borrow from the company.

While many directors borrow from the business throughout the year then settle the issue by the year end by paying cash back to clear what they have borrowed, complexities can arise when your DLA becomes overdrawn.

Understanding Overdrawn Director’s Loan Accounts

Director’s loan accounts
become overdrawn when the director takes money away from the company that cannot be classed as a dividend, loan repayment, or wage, and the money taken exceeds the amount of cash that has been put into the business.

An overdrawn director’s loan is not as worrisome as you might think – particularly if you and your accountant are capable of keeping track of the amount of money that is owed to the company, and you can eventually afford to repay the cash you have borrowed.

However, if you find that you are unable to repay your director’s loan by the company’s year-end, then some serious problems can begin to arise, particularly if the money that is owed to the company is a higher amount than £10,000.

In these circumstances, the HMRC will consider the amount you have borrowed to be an interest-free loan that you are benefitting from without cause. As a result, they’ll expect you to pay personal income tax on your loan.

At the same time, further problems can arise when the overdrawn director’s loan in question is still outstanding more than nine months after the end of year accounting period for the company.

What’s important to keep in mind is that an overdrawn director’s loan account isn’t illegal – or it hasn’t been since the commencement of the Companies Act of 2006.

The only noteworthy stipulation to keep in mind is that no director should benefit from a loan of more than £10,000 without approval from a shareholder.

It’s worth noting that director’s loan accounts can only be repaid in three ways:

  • Cash-repayment – The director might choose to repay the overdrawn loan balance in cash. At the same time, he can offset any unpaid mileage claims, expense claims, or work-from-home allowances.
  • Dividend – If the company is profitable enough, and the director in question is also a shareholder, a dividend could be declared to clear the director’s loan account balance.
  • Payroll – If the company isn’t profitable enough to declare a dividend, and the director doesn’t personally have the cash to pay back the overdrawn loan account, then it could be possible to pay a bonus in payroll that can be offset against the director’s loan account.

Tax Implications of an Overdrawn Director’s Loan

A director cannot simply take money out of a company in the form of a director’s loan, and not expect to pay some tax on it. In other words, if you’re dealing with overdrawn director’s loans, the chances are that you’ll have a number of tax concerns to deal with.

Even if your company is heading towards liquidation, or has already been classified as insolvent, any untaxed income that you have to deal with will be scrutinized and subject to charge.

In certain circumstances, the HRMC may not classify your director’s loan as a form of personal income because it is a company asset that is owed to the business. Because of this, they must deal with the concept using a specific set of rules.

The rules indicate that if your overdrawn director’s loan account remains overdrawn for more than nine months following the end of your company’s accounting period, you will be subject to pay a penal rate of tax. This tax is charged to the company at a rate of 25%.

Importantly, this is completely irrespective of corporation tax, regardless of whether your business has made losses or profits, or whether tax has been paid.

No matter the circumstances, your tax charge on the overdrawn DLA will still be payable, and must be paid as with standard corporation tax, nine months following the company accounting period. If the tax is paid on time, then it is refundable.

However, it’s worth noting that recovering this specific tax can be a particularly complicated and time-consuming process.

What to look out for with a Director’s loan account

Primarily, directors loan accounts should not be considered as a devastating or worrying situation. However, it is important for companies to be aware of the pitfalls they have to look out for. For example:

  • Make sure you don’t owe more than £10,000 – If the director’s loan account is overdrawn by more than this amount it will be classed as a benefit in kind, because you are receiving a loan without interest. In this situation it must be declared on a personal tax return and income tax will need to be paid according to HMRC’s interest rate.
  • You need to worry about more than just you – In the eyes of the HRMC, the director’s loan that is built up will also include anyone classed as an associate to the director – which can be a civil partner or spouse, a relative, business partner, trustee, or loan creditor. If the business is lending to someone connected closely to you, or on your behalf, it will be classed as part of your director’s loan, rather than a separate instance.
  • Pay the company back at the year-end – Remember that the money you take out must be settled by the year end. A number of people are frequently caught out because they forget that dividends get paid after tax, and they aren’t left with enough cash to fully clear the director’s loan without them. If you end up owing money in an overdrawn director’s loan account, then you’ll need to declare this on your corporation tax.
  • You do have time – If you can pay the overdrawn amount back within nine months of your year-end in regards to accounting, then you won’t have any tax to pay. However, you will still be required to declare the loan on your corporate tax return.
  • Be Careful – Remember however that the HMRC are growing wise to directors who pay off their loan just before the nine-month date then take the money straight back out again after the time is up. If the amount is repaid and taken out within thirty days, the HMRC will class the loan as unpaid.

The best way to look after your business is to make sure that if you borrow money from the director’s loan account, you ensure you only take as much as you can afford.

In other words, don’t take more cash out of the account than you are able to clear with dividends, or you’ll end up paying tax at a rate as high as 25%. Remember, when you’re working out how much to borrow, don’t forget that dividends come out after tax, so allow for tax first.

 

If you want to know about this topic, have a look at some of these articles:

Liquidation: directors’ investigations explained

What happens to a director’s loan account within liquidation?

Director’s loan accounts explained