What Is A Director’s Loan Account & How Does It Work?

directors loan account

If you have ever considered borrowing money from your company or loaning some of your own hard-earned cash to the business, then you will need to have a firm grasp of what a director’s loan is and how a director’s loan account works. IN Accountancy is here to provide you with all the relevant information you need to understand the complexities of director’s loan accounts.

Contact In Accountancy to learn more about directors’ loan accountants!

What Is A Director’s Loan?

A director’s loan is any money you take out of the business that is not salary, dividends, legitimate expenses, or money you have loaned to the company yourself. Director’s loans can either be useful (albeit infrequent) outgoing sources of personal funds or incoming cash injections from a director to boost cash flow. Either way, the company or the director will need to be repaid.

Directors loan account example: If a director loaned the company £1,500 to pay a supplier, that is a director’s loan to the company. The director is then entitled to reclaim that amount plus interest.

 What Is A Director’s Loan Account?

A director’s loan account (DLA) records the money you owe the company and need to pay back, as well as the money that the company owes to you. You can reclaim money owed to you free of income tax when there is enough cash available in the business to do so. A DLA is more of an accounting term than a physical bank account where actual money goes in and out. It is how accountants “account” for what you do with the money in your business.

Remember: As a limited company, you and your business are two completely separate legal entities. That means your money is not the business’ money and vice versa. 

Every individual director must have their own DLA, which can typically be tracked using many of the latest accounting software packages. This is something to discuss with your accountant. Every accountant worth their salt should show you precisely what they have put into your DLA so you know exactly where you stand. Don’t be surprised if they use your DLA to challenge how certain expenses have been allocated from time to time!  

What Should A Director’s Loan Account Contain?

When you look at your director’s loan account transactions with your accountant, you will see that you will have debits (DB) on the left-hand side and credits (CR) on the right. The debits are what you owe to the company. To use a business analogy, debtors are like customers who owe the company money. Credits are what the company owes to you. Likewise, creditors are the equivalent of suppliers who need to be paid by the company.

Debits are also known as “drawings”, which can relate to director’s loans or money set aside for dividends (which can only be paid out of profits). The latter type of drawings sits on the left-hand side of the DLA until they are turned into a dividend. This is done by holding a board meeting, completing the meeting minutes and raising the appropriate dividend documentation. There is a lot of compliance and paperwork involved!

Other debits include items that you have inadvertently paid for with business money. Some of the things we commonly see include personal shopping (whereby purchases were mistakenly made using a company bank card!), petrol for domestic journeys, Apple or Netflix subscriptions, personal magazine subscriptions, and Uber Eats bills. These are exactly the type of things accountants will challenge as not being legitimate business!

In the right-hand column for credits, you might see your salary or dividends if you haven’t drawn the money for those out of the business. Any capital introduced on starting your company may also be included. Then there will be anything else you have paid for personally, which is a genuine business expense. This can include a laptop or mobile phone bill that was once for personal use but is now used for business. Other credits might include train tickets bought for business trips, Business Mileage claims and use of home allowances.

How Much Can I Borrow In A Director’s Loan Account?

There is no legal limit to how much you can borrow from your company. However, you should think carefully about how much money your business can afford to loan – and for how long – without creating cash flow problems. It is also worth bearing in mind that any loans worth £10,000 or more are automatically considered a “benefit-in-kind”. 

As such, you will need to report these as part of your Self-Assessment, and you will be required to pay tax on the loan at your marginal rate. The company will also be required to file a form P11D and pay class 1a National Insurance Contributions, currently at a rate of 13.75%, on the value of the loan. For those reasons, the approval of all shareholders should be sought for loans of this magnitude. 

What Happens If My Director’s Loan Account Is Overdrawn?

If you owe money back to the business, your DLA is in “debit” or “overdrawn”. If you have an overdrawn director’s loan account, your accountant will explain your options, which include (but are not limited to) the following:

  • Issue a dividend – You might choose to issue a dividend to clear the balance, assuming the business has enough reserves. Remember that personal tax will be due on any dividend declared. 
  • Pay back debts – Another option is to pay what is owed in whole or part before the Corporation Tax payment deadline. The deadline falls nine months and one day after the company year-end date.
  • Pay Section 455 tax – You could choose not to pay it back but instead pay Section 455 (S455) Corporation Tax on the outstanding amount. This is set at 33.75% for the 2022-23 tax year, in line with dividend tax increases.

What Happens If My Director’s Loan Account Is In Credit?

If your director’s loan account is in credit, it simply means that the company owes that money to you. If it isn’t a significant amount in credit, you can draw this back at any time in the future when the company can afford to pay you. Any money drawn in this way is not subject to income tax because it was your money in the first place. However, if the company owes you significant funds, you may wish to charge interest on that loan.

HMRC is quite happy for directors and shareholders who loan their business funds in this way to treat these as unsecured loans and charge an appropriate commercial interest rate of circa 5%. As such, director’s loan interest rates are significantly more than you might receive investing in any bank currently. But again, there are rules around this. For instance, you can’t treat it as a savings account and loan spare cash to the business simply to charge interest on it. There must be a genuine business need for the loan.

As ever, there is quite a lot of complexity and paperwork involved in the process. For example, you might have to undertake CT61 reporting and pay any income tax due on the interest earned. Therefore, the administrative burden involved in managing director’s loans can often outweigh the benefits for less significant amounts.

Is There Any Interest On A Director’s Loan?

If your director’s loan account is overdrawn at your company’s year-end, whether you pay tax on the loan or not depends on how quickly you pay back the debt. The Company won’t have to pay any tax on an overdrawn director’s loan account if you pay back every penny within nine months and one day of your year-end date. 

However, if you take longer to repay the loan, the company will need to pay an extra 33.75% in Corporation Tax on the outstanding amount. Although this amount can be claimed back, it is a lengthy process and, therefore, best avoided wherever possible. Please note that any class 1a National Insurance Contribution Tax paid by the company cannot be reclaimed.

Directors loan account example: If your DLA was overdrawn at your company year-end of 30 April 2022, you would need to repay the loan by no later than 1 February 2023 to avoid hefty Corporation Tax charges.

Conclusion

Director’s loan accounts are an accounting tool to record all the money you take out and put into your business. Director’s loans can be a valuable means of drawing money out as a last resort to cover unexpected personal expenses or to inject money into the business to help with cash flow. Business loans must be repaid within nine months and a day after your company year-end date to avoid hefty additional Corporation Tax levied at 33.75%. 

These punitive charges, along with the onerous admin and extra scrutiny from HMRC and shareholders that recurring and excessively overdrawn DLAs can attract, make director’s loans the type of economic lever that should only be used infrequently as a last resort. 

For more information about director’s loans and how IN Accountancy can help your business to remain solvent and compliant, please get in touch with the team. Contact us on 0161 456 9666 or email askus@in-accountancy.co.uk. To find out more information watch the video below.

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