For sole traders and partnerships, taking money out of the business is a relatively straightforward procedure without any undue tax implications. It’s more complicated when you take money from a limited company as it’s considered a detached legal entity.
A director’s loan account isn’t a real bank account. It certainly isn’t the company’s own bank account for example.
It’s a virtual account that only exists within the accounting records of the company as a way of keeping track of the flow of money between the limited company, and the director as an individual.
The money made by a limited company belongs to that company and not to the director personally so taking money out, putting money in and monitoring the flows can be complicated.
Putting money in and taking money out
Every business owner has had times when they’ve been concerned about their company’s cash flow. Sometimes they’ll feel that they need further assistance including from personal funds especially in the early days of running a business.
If you put money into the company bank account then you’re making a loan to the business – which means that you’ll 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.
Similarly, 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’s owed to you.
An important point to keep in mind at all times is that you can take the money you’ve put into a company back at any time. You can access this money via wages, dividends or as a cash repayment of a loan that you’ve previously made.
If the money is removed from the company and it isn’t a dividend, wage or loan repayment then you’ll 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 financial year end by paying cash back to clear what they’ve borrowed and balance the account – complexities can arise if a DLA becomes overdrawn.
Understanding Overdrawn Directors Loan Accounts
Director’s loan accounts become overdrawn when the amount withdrawn exceeds the amount of cash they’ve put into the business.
An overdrawn director’s loan account isn’t as worrying as you might think – particularly if you and your accountant are able to keep accurate track of the amount of money owed to the business and if you can eventually afford to repay the cash that’s been borrowed.
If you’re unable to repay the director’s loan by the end of the financial year then there could be some issues, especially if the amount owed is greater than £10,000.
In these circumstances, the HMRC will consider the amount borrowed to be an interest-free loan that the recipient benefits from without cause. In these circumstances, they will expect you to pay personal income tax on your loan.
More problems could also arise if the overdrawn account in question remains outstanding after more than nine months after the end of the company’s financial year.
Overdrawn director’s loan accounts aren’t illegal and haven’t been since the commencement of the Companies Act 2006 but they no director should benefit from a loan greater than £10,000 without approval from a shareholder.
Repaying a Director’s Loan Account
There are three ways that a DLA can be repaid:-
Cash repayments – The director might choose to repay the overdrawn loan balance in cash. If they choose this method then at the same time they can offset any unpaid mileage claims, expense claims or work-from-home allowances.
Dividends – If the company is profitable enough and the director in question is also a shareholder then a dividend could be declared to clear the DLA 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 DLA then it could be possible to pay a bonus in payroll that can be offset against the DLA.
Tax Implications of an Overdrawn Director’s Loan Account
Directors cannot simply take money out of a company in the form of a DLA without paying some sort of tax on it.
Even if a company is facing liquidation or already insolvent, any untaxed income will still have to be dealt with, scrutinized and subject to charge.
In certain circumstances, the HMRC may not classify your director’s loan as a form of personal income because it’s a company asset that’s owed to the business. Because of this it has to be dealt with using a specific set of rules.
These indicate that if the overdrawn DLA remains overdrawn for more than nine months following the end of the financial year then it will be subject to a penal rate of tax. This is charged to the company at the rate of 25%.
This is irrespective of corporation tax, regardless of whether the business has made losses or profits or whether tax has been paid.
No matter what the circumstances, the tax charge on the overdrawn DLA will still be payable and must be paid within the nine months following the company accounting period. If it’s paid on time then it’s refundable – although trying to recover this specific tax it can be particularly complicated and time-consuming. .
Director’s Loan Account – Key Points to remember
By themselves DLAs shouldn’t be considered devastating or the critical last step in a business failure – but they are important enough for companies to be aware of some of the more important pitfalls to watch out for.
- Make sure you don’t owe more than £10,000
If the DLA is overdrawn by greater than this amount then it will be classed by HMRC as a benefit in jind because you’re receiving a loan without interest. In this situation it has to be declared on a personal tax return and income tax will need to be paid at HMRC’s interest rate.
- It’s not just about you
In the eyes of the HMRC, the DLA will also include anyone classed as an associate to the director. This can be a spouse or civil partner, a relative, business partner, trustee or a loan creditor. If the business is lending to someone closely connected to you or on your behalf, it will be classed as part of the DLA rather than a separate instance.
- Pay it back by the end of the financial year
Any money you’ve taken out in a DLA must be settled by the financial year end whether it be March 31st or a different date. This may catch some people out because they forget that dividends get paid after tax and they aren’t left with enough cash to fully clear the directors loan account without them. Anybody owing money on an overdrawn DLA will have to declare it on their corporation tax return.
- There is time to pay
The DLA doesn’t have to be repaid straight away. If the overdrawn amount can be repaid within nine months of the end of the financial year then there won’t be any additional tax to pay. This would still have to be declared on any corporation tax return however.
- HMRC is watching
The HMRC are increasingly aware of directors who pay off their DLA just before the nine-month deadline then take out another DLA straight away once this deadline is expired. As a result, if the amount is repaid and taken out again within 30 days, then HMRC will class the loan as unpaid.
Ultimately, the best way to look after your business is to make sure that if you borrow money in a DLA then only take as much as you can afford to repay.
In other words don’t take out more than you are able to clear with dividends otherwise you’ll end up paying tax on it as high as 25%. Remember you’re working out how much to borrow and dividends come out after tax so make sure to allow for tax.