Directors Loan Account
Often when we go through a set of accounts with a client, one of the areas that causes the most confusion is the Director’s Loan Account.
What’s is a directors loan account?
Directors’ relationships with their own company are unique because they are in the privileged position of being able to influence their company’s actions and activities in a way that others such as employees, suppliers and customers cannot.
Therefore, a director loan account is set to record and manage the transactions between the director and the company, even if you own the whole shares in the company, the company still being treated as different entity form you.
When you set up the business, you probably had to put a bit of money in to get it going. That is treated as a loan. A loan from you, the Director of the business to the company.
As the company goes forward, there are transactions on this loan where, for example, you might buy some things on behalf of the company such as paying for a parking ticket or a taxi. Perhaps you use your own credit card for some purchases. In these instances, you’ve used your money to pay for things on the company behalf. Therefore, the company owes money to you the Director which credited to your Director’s Loan Account.
The other side is, there are times when the company pays for things for you. Perhaps you used the company bank card to pay for a personal meal. The main example is when the company transfers money from its bank account to yours, and that money isn’t already declared as a salary or a dividend. It’s just a cash transfer.
In a small business, this is pretty common. You are the owner and manager of the business and transferring money to and from your own bank account is relatively common. The key thing is that it is all part of the Director’s Loan and it must be accounted for as such.
What we find is that, when clients first come to us they may see a figure on a Director’s Loan Account at the yearend and not know what it is. However, when they see the individual transactions one by one throughout the year, it usually does make sense.
You as a Director have to be aware of the rules over that loan account. In particular, you need to understand the rules when the Director owes money to the company and the simple way to look at it is to think of this account as a bank account, if account shows a negative balance then you owe money to the company.
It is fine for the company to owe you money but, generally, you shouldn’t just be taking cash out of the business without it being accounted for properly as a salary or a dividend, or as a Director’s Loan.
Tax implications
If your Director’s Loan Account is overdrawn, i.e. you owe money to the company, there may be a tax impact.
HMRC doesn’t want you to just take money out of the company, call it a loan, and neither you nor the company to pay tax on it. If you are taking money out of the company, ultimately it should be a dividend or salary, which has a tax impact.
Therefore, HMRC has a few rules on overdrawn Director’s Loans.
Business Tax
The first rule is that, if you owe money to the company at the accounting yearend, the company should pay corporation tax at a rate of 32.5% on the balance of that loan.
The exception is that, if the loan is repaid within nine months of the year end, you do not have to pay the tax.
As an example, if your year end is 31 December 2017 and you owe your company £10,000, there is a tax charge of £3,250 unless you repay the money by 30 September 2018. Not entirely accidentally, 30 September 2018 is also the deadline date for filing your accounts and tax for the year.
The reason for this is to stop you running off and not paying any tax.
The good news is that, when you do repay the loan, HMRC will refund the tax to the company. However, there may well be a time lag, i.e. you may pay the tax in one year’s tax return and then get it back a year later.
But the point is that it’s a way of HMRC stopping you running off without paying any tax. They are happy to pay it back when you put the loan back to zero.
Personal tax
If the loan is more than £10,000, there is actually a tax “benefit-in-kind” on you personally. This is because you’ve had a loan without paying any interest.
HMRC assume that you have avoided paying interest and want tax on that benefit. They have their own rate which currently 3.25%.
If a company will cease trading and will be closed it’s worth being aware that, if the company closes, any overdrawn loan needs to be repaid by the Director. The Director remains liable for this personally.
Offsetting the Overdrawn balance
There might be in situation where the company has two directors (i.e. husband and wife) and one director owes money to the company, while the other is owed money. To be able to offset these balances, the directors must formally agree in writing (proper documentation should be kept) before any offsetting takes place.
Business Implications
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.
However, if you have other three directors involved in the company, the director loan account will be cost control technique, so each director can be account for the
We use online portals such as Xero and Freeagent which allow directors to have a real time accounting, and such directors loan accounts are being monitored constantly on a crystal-clear dashboard and fluctuated whenever a transaction is recorded on one of the directors’ accounts.
If you’d like to know how we can help you with all of this, feel free to give us a call on 0333 090 0407 or write to us here.