What is a director’s loan account?
A director’s loan account is one of the areas that often causes confusion for limited company owners.
It matters because a limited company is legally separate from its directors and shareholders. The company’s money is not the same as your personal money, even if you own and manage the company.
A director’s loan account records money moving between you and the company that is not salary, dividends, expense reimbursement, or normal company trading income.
Is a director’s loan account a real bank account?
No. A director’s loan account is not a separate bank account that you need to open.
It is an accounting record that appears in the company’s bookkeeping and accounts. It tracks whether the company owes money to you, or whether you owe money to the company.
When the company owes money to the director
Your director’s loan account may show that the company owes you money.
This can happen when:
- You put personal money into the company
- You pay company expenses personally and are not reimbursed
- Salary is processed through payroll but not actually paid to you
- A dividend is declared but not yet paid to you
- You leave money in the business to support cashflow
In these situations, the director’s loan account normally has a credit balance. This means the company owes money to the director.
When the director owes money to the company
Your director’s loan account may become overdrawn if you take money out of the company that has not been properly treated as salary, dividends, or reimbursement of expenses.
This can happen when:
- You withdraw company money for personal use
- Personal expenses are paid from the company bank account
- You take more money from the company than has been declared as salary or dividends
- Transactions are made without checking whether the company has sufficient profits to support dividends
In these situations, the director owes money back to the company.
What is an overdrawn director’s loan account?
An overdrawn director’s loan account means that you owe money to the company.
This is not always a problem if it is temporary and dealt with properly. However, if the balance remains outstanding, it can create additional tax consequences for both the company and the director.
An overdrawn loan can usually be dealt with in one of three ways:
- Repaying the money personally into the company
- Processing additional salary through payroll
- Declaring dividends, if you are a shareholder and the company has sufficient distributable profits
Dividends are only possible where the company has enough post-tax profits available. They should be properly documented and should not be used as a shortcut if the company cannot legally support them.
Additional Corporation Tax on overdrawn loans
Where a company lends money to a director who is also a shareholder, this may fall under the close company loan rules.
If the loan is not repaid within 9 months and 1 day of the company’s year end, the company may need to pay additional Corporation Tax, commonly known as a Section 455 tax charge.
The charge is based on the outstanding loan balance. It is separate from the company’s normal Corporation Tax liability.
The tax may be reclaimable if the loan is repaid later, but the repayment process can take time. It is usually better to plan ahead and avoid the additional tax charge where possible.
Repaying and then taking the money out again
It is not usually possible to avoid the tax charge simply by repaying the loan just before the deadline and then taking the money out again shortly afterwards.
HMRC has anti-avoidance rules that can apply where a loan is repaid and then replaced with a new loan. These are often referred to as “bed and breakfasting” rules.
For example, if a director repays a loan and then withdraws a similar amount again shortly afterwards, the repayment may not have the intended effect for tax purposes.
This is why it is important to look at the pattern of withdrawals and repayments, not just the balance on one particular day.
What if the loan is written off?
A company can choose to write off a director’s loan, but this also has tax consequences.
The amount written off may be treated as income for the director, often in a similar way to a dividend for tax purposes. There may also be National Insurance implications, depending on the circumstances.
Writing off a loan should not be treated as a simple way to make the issue disappear. It needs proper advice and careful handling.
Benefit in kind implications
An overdrawn director’s loan can also create a personal tax issue if it is interest-free or charged at a reduced rate.
If the loan exceeds £10,000 at any point in the tax year and the company does not charge interest at HMRC’s official rate, it may be treated as a beneficial loan.
This can create a taxable benefit in kind for the director, and the company may need to report the benefit to HMRC.
Unlike the additional Corporation Tax charge on certain overdrawn loans, benefit in kind tax is not normally reclaimed simply because the loan is later repaid.
How to avoid director’s loan problems
The best way to avoid problems is to plan how money will be taken from the company before withdrawals are made.
A director should normally understand:
- How much salary is being processed through payroll
- Whether dividends are available and properly declared
- Which expenses can be reimbursed
- Whether personal spending has accidentally gone through the company
- Whether the director’s loan account is building up an overdrawn balance
Random or unchecked withdrawals can quickly create a director’s loan issue, especially where the company does not have enough profits to support dividends.
Review the position before the year end
Director’s loan accounts are much easier to manage when they are reviewed regularly.
If the account is becoming overdrawn, it is usually better to identify the issue before the company year end, rather than trying to fix it after the accounts are being prepared.
Regular bookkeeping and clear communication with your accountant can help avoid unexpected tax charges.
Speak to your accountant early
Director’s loan accounts are manageable when they are reviewed regularly and dealt with before they become a year-end problem.
If you are unsure whether your director’s loan account is overdrawn, or you need advice on the most appropriate way to take money from your company, CooperFaure can help.
We support limited company directors with accounts, Corporation Tax, payroll, dividends, bookkeeping and practical tax planning.