What Is A Director's Loan Account?
Many people find the topic of director's loan accounts confusing, particularly when it comes to reporting them and understanding their impact on the company's financial position. Therefore, having a solid understanding of how these accounts function is crucial for conducting business effectively.
To put it simply, a director's loan account refers to money that is transferred between you, as a director, and the company, which cannot be categorised as salary, dividend, or expense payments. It is money that is to be repaid eventually. These loans can flow in both directions, meaning the director can lend money to the company, or the company can lend money to the director.
Director's loans are common in most new businesses, as directors often loan to the company to cover its expenses until it begins generating its own revenue. It's important to note that every transaction involving a director's loan must be documented, meaning a record known as the "director's loan account" should be kept.
Separation Between A Company And Its Directors
A key aspect to consider when discussing director's loans is the distinction between a company and its director. Once a business is incorporated, the business becomes a separate legal entity, independent from its directors. As a result, it operates as its own entity. It is essential to establish a clear separation between the company’s funds and the director’s personal funds.
What Is A Close Company?
A close company is a privately held business which is owned and controlled by five or fewer participators (shareholder, director, loan creditor), often closely involved in its management. Close companies are often family-owned or small private businesses, with shareholders typically being the directors or managers.
The key features of a close company are:
- Limited Number of Shareholders: Close companies typically have five or fewer participators. This ensures that the company remains closely held by its members.
- Control by Shareholders: In many close companies, the shareholders are also involved in the management of the company, and decision-making is mainly in their hands.
- Ownership and Management: Shareholders in a close company are often the directors. Meaning that ownership and management are typically held in the hands of a few people, such as family members, close friends, or business partners.
Examples of Close Companies:
- Family-owned businesses: These businesses are often close companies, where the family members own and run the company.
- Small, private companies: Companies that are privately held and not traded on the stock market often operate as close companies.
Director's Loan - Lending To The Company
A director typically lends money to their company to support ongoing operations or to purchase new assets. The director may choose to charge interest on the loan, which must be reported as income on their Self-Assessment tax return.
When a director provides a loan to the company, it is classified as a creditor on the company's balance sheet. It can be recorded as either a short-term creditor (if repayment is expected within one year) or a long-term creditor (if repayment is expected after more than one year). The classification of the loan will depend on when the company is able to repay the director.
Advantages of lending to your own company:
- Quick and easy: A director's loan is often a straightforward way for a director to lend money to their business, without the need for complex documentation or formal processes.
- Does not impact the shareholder structure: Since the loan is between the director and the company, it doesn't alter the ownership or shareholding structure of the business.
- No restrictions on how you can use the funds: Unlike some other forms of financing (e.g. loans from financial institutions), the company generally has flexibility in how it uses the loan funds.
- Allow the director to control the repayments: The repayment schedule can be determined by the director, allowing more flexibility in managing cash flow.
- Interest can be charged on directors loans: The company can treat the interest paid as a business expense and therefore reduce the businesses tax bill.
Director's Loan - Company Lending To The Director
On the other hand, if the director withdraws funds from their company's bank account that cannot be classified as salary, dividend payments or repayment of funds previously paid into or loaned to the company, then these deductions must be recorded in the director's loan account (DLA).
If the company lends money to the director or a close family member this transaction has to be reflected in the company's accounts (specifically the balance sheet) and if the loan was outstanding (still owed to the company) at the end of the accounting period it will have to also be reported by the company when filing its corporation tax CT600 return.
Director's Loan Account (DLA)
A director’s loan account (DLA) keeps track of the transactions between a company and its director. Any withdrawals made by the director from the company or any loans given to the company must be recorded in the DLA. If the DLA shows a credit balance, this means the company owes money to the director, meaning there are no tax implications. However, if the DLA shows a debit balance, indicating that the director owes money to the company, there may be additional tax obligations for both the director and the company.
What to include in a director's loan account:
- Every transaction which shows company money being used for personal expenses (which isn't your salary or dividend payments)
- Personal money that you use for the company, including director's loan repayments.
- Any cash withdrawals from the company that are not business related.
Business expenses must be incurred wholly and exclusively for the purpose of trade.
When Should Director's Loans Be Repaid?
If a Director's Loan Account (DLA) is overdrawn at the end of the company's accounting period, both the director and the company may need to pay tax. Any outstanding balance will result in the company having to pay an additional 33.75% corporation tax (also known as S455 tax) on the unpaid director's loan amount. However, if the full balance of the director's loan is repaid within 9 months and 1 day after the end of the company's accounting period (which coincides with the deadline for any corporation tax payment), there will be no tax implications. For instance, if a DLA is in debit as of the company's year-end 31 May 2024, then the loan must be repaid by 1 March 2025.
How Can Corporation Tax Be Claimed On An Overdue Director's Loan?
A company can reclaim the corporation tax it has paid on a director's loan that has been repaid, written off or released. However, it is important to note that any interest paid on the loan cannot be reclaimed. The tax can only be reclaimed 9 months and 1 day after the end of the corporation tax accounting period in which the loan was repaid, written off, or released and it cannot be refunded before this date.
Reclaiming Within 2 Years
If corporation tax is reclaimed within 2 years of the end of the accounting period when the loan was taken out, then the claim can be done when completing the corporation tax return for the period the loan was taken out or by amending it online.
Reclaiming After 2 Years
If reclaimed 2 years or more after the end of the accounting period when the loan was taken out, then the L2P form should be completed and either included with the latest CT600 return or post it separately to HMRC.
How Will HMRC Repay Your Company?
HMRC will either repay by using the repayment details in the latest corporation tax return or by sending a cheque to the company's registered address (usually done within 30 days).
Can A Director Repay Their Director's Loan And Then Take Out Another?
Additionally, measures have been introduced to prevent directors from avoiding tax through a method known as "bed and breakfasting." This term refers to the strategy where a director repays their outstanding loan before the company's year-end to avoid additional tax, only to immediately take out another loan with no intention of repaying it. Furthermore, if the director's loan is in excess of £10,000 and is repaid by the director, then no further loan over this amount can be taken within 30 days. HMRC views this as an indication that the director does not intend to repay the loan, meaning the full amount will be subject to tax.
To Sum Up - Director's Loan Checklist
Director's loans can give directors access to more funds than they are currently receiving via their salaries or dividends and can be typically used to cover unexpected bills. Nevertheless, it is important to note that director's loans are a tricky area, closely monitored by HMRC. Here is a short summary of the main points to remember when it comes to director's loans:
- Only take out director's loan when necessary.
- Repay any outstanding director's loans within 9 months and 1 day after the company's accounting period end date.
- If you, as a director, lend money to your company, ensure that both you and the company use the correct tax treatment.
- Benefit in kind will not arise if the loan is less than £10,000, or, if the director is paying interest on the loan.
Looking For More Information?
Hopefully this article has helped clarify what a director's loan is and how you can use it to benefit your small business. For more information on topics related to running a business, feel free to explore our Knowledge Base. If you're looking to set up a new company to start your business journey, you can easily do so through our affordable Incorporation Service at Easy Digital Company. If you have any additional questions about running a business, don't hesitate to reach out to us here.
