What is a director’s loan account, and what are the tax implications?

What is a director’s loan account, and what are the tax implications? | A freelancer hard at work | Crunch

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    When you’re running a limited company, there’ll be various pieces of legislation that you might hear about, but don’t fully understand. Director’s loan accounts (DLAs) are one of those fiddly bits of tax legislation that you really do need to know about.

    This article will cover exactly what a director’s loan is, the guidelines to follow, and your tax obligations. We’ll explain everything you need to know about the director's loan account with as little jargon as possible.

    What are director’s loan accounts?

    Although the money in your limited company bank account belongs to the company, as a director of the company, you can make withdrawals using a director’s loan.

    HMRC defines a director’s loan as money taken from your company that isn’t either:

    • A salary, dividend or expense repayment
    • Money you’ve previously paid into or loaned the company.

    If you have paid business expenses personally, you can pay yourself back using the company bank account.

    All other withdrawals you make from your company bank account must be recorded in your personal DLA. If a company has more than one director, each director must have their own DLA.

    As long as your personal DLA remains in credit, the company owes you money and you don't have to pay any tax. However, if your personal DLA has a debit balance, it means your DLA is overdrawn and you owe the company money. The balance is effectively an interest-free loan which may need to be reported to HMRC as a benefit in kind - we’ll cover this later. 

    At the end of your company’s financial year, depending on the position of your DLA, you’ll either owe the company money or the company will owe you money. This will be recorded as an asset or a liability in the balance sheet of your company’s annual accounts.

    What should a director’s loan account contain?

    Items you should record in your DLA are:

    • Any cash withdrawals from the company that you’ve made as a director
    • Personal expenses which were paid with company money or credit cards.

    Business expenses must be incurred wholly and exclusively for the purposes of the business. Anything you purchased using company resources that fails this test is a personal expense. For the lowdown on business expenses and what you can and can’t claim, download our guide to business expenses.

    Business Expenses made simple with our guide.

    This is a really risky area of running your own limited company, and for this reason, HMRC will keep your DLA under review through the company’s annual tax returns to ensure their rules and guidelines are being followed.

    Who can take a director’s loan?

    As the name suggests, you need to be a director to take a loan from your company.

    Why would you want to take a loan?

    There are many reasons why you might need to take money from your company, for example covering an unexpected personal expense.

    The important thing to remember is that the money still belongs to the company and is effectively a loan to you personally. The loan hasn’t been subject to either personal or company tax and HMRC is going to want what’s due.

    When will I have to pay tax on a director’s loan?

    If your DLA is overdrawn at the date of your company’s year-end, you may need to pay tax. If you pay back the entire director’s loan within nine months and one day of the company’s year-end, you won’t owe any tax. In other words, if your DLA is overdrawn at your company year end of 30th April 2022, the loan must be paid back by 1st February 2023.

    Any overdue payment of a director’s loan means your company will pay additional Corporation Tax on the amount outstanding. For the 2022/23 tax year, the rate is 33.75% which is the higher rate of dividend tax. In the 2021/22 tax year, the rate was 32.5%. 

    This extra 33.75% is repayable to the company by HMRC when the loan is repaid to the company by the director. There may be personal tax to pay at 33.75% of the loan amount if you do not repay your director’s loan. This is not repaid by HMRC when the loan is repaid.

    To illustrate the above, ABC Limited has taxable profits of £5,000 with a Corporation Tax bill of £950 (£5,000 x 19%).

    During the accounting period, the director's loan account (DLA) was overdrawn by £15,000 and remained unpaid nine months and one day after the accounting period ended. 

    The first implication for the company is that it must pay additional Corporation Tax of £5,062.50 (£15,000 x 33.75%) because of the overdrawn DLA.

    The total Corporation Tax to pay for the accounting period is £6,012.50 (£950 + £5,062.50). The £5,062.50 can be reclaimed by ABC Limited at some point in the future if the director repays the loan back or the company decides to write off the loan to the director.

    If the loan is written off by ABC Limited, then tax must be paid on the loan by the director as dividends. The director will need to include the written off loan on their annual Self Assessment tax return and pay tax personally at the dividend higher rate threshold of 33.75%.  

    A further implication of an overdrawn DLA for the director is declaring a benefit in kind on Form P11D as detailed below.

    A third and final implication of the overdrawn director loan account is that the company has to pay employers national insurance contributions. For the 2022/23 tax year the rate is 15.05% of any benefit in kind provided, including the director’s loan. In the 2021/22 tax year the rate was 13.8%.

     Your personal tax position depends on the whether the loan is written off by the company or not: 

    If ABC Limited has not written off the loan the director must include it as a benefit in kind as stated in Form P11D on their Self Assessment. 

    If ABC Limited has written off the loan, and reclaims £5,062.50 from HMRC, the director will need to include £15,000 as dividends on their Self Assessment plus any benefit in kind as stated on Form P11D (if applicable)

    HMRC will then calculate the amount of personal tax due as part of the overall personal tax liability.

    Do I need to record director’s loans?

    Yes. It’s important that you understand your relationship with the company as legally separate – when you created your limited company, you established it as a legal entity. This means that it has its own statutory obligations and accountability and for this reason, everything taken out must be recorded in your company's accounts.

    What happens if I owe my company money?

    If you owe your company over £10,000 (interest-free) at any given time, the total loan amount is classed as a benefit in kind and you’ll need to record it at the end of the tax year on Form P11D, as it’ll be liable to both personal and company tax. For the 2022/23 tax year, your company will need to pay Class 1A National Insurance at the 15.05 % rate on the full amount. In the 2021/22 tax year the rate was 13.8%.

    As a general rule for loans of more than £10,000, shareholder approval must be given beforehand. For most smaller companies a director is also a controlling shareholder so the approval is more a formality rather than a legal issue.

    If the company owes you money

    Your company doesn’t pay any Corporation Tax on money you personally lend to it and you can withdraw the full amount from the company at any time.

    If you charge any interest, this will be classed as a business expense for your company and personal income for you. The interest amount must be declared as income on your Self Assessment and taxed accordingly.

    Interest rates on Director’s Loans

    If you lend money to your company or take a Director’s Loan from your company there are detailed rules about the timings of repayments and any interest charged or received. The site explains the various rates and rules you need to know – we recommend you speak to an accountant to ensure you don’t fall foul of HMRC.

    ‘Bed and Breakfasting’

    The government introduced measures to stop directors managing their DLAs in a way that means they might avoid tax, known as bed and breakfasting.

    This is a method sometimes used by directors to dodge tax by repaying their borrowed money to a company before the year-end to avoid penalties, only to immediately take it out again without any real intention of paying the loan back.

    When a loan in excess of £10,000 is repaid by the director, no further loan over this amount can be taken within 30 days. When this happens, HMRC’s view is that the director doesn’t intend to pay the money back and the full amount will be taxed.

     The ‘bed and breakfasting’ of a loan which falls outside of the 30-day rule, may still be subject to tax where the loan is in excess of £15,000. The rules state that where a loan of over £15,000 has been made to a director of the company, and before any repayment is made there is an intention to take a future loan of more than £5,000 which is not matched to another repayment, then the bed and breakfast rules apply.

     So, if you make a repayment towards your director’s loan of more than £15,000 within 30 days, and intend to take a new loan of over £5,000 in the future, the ‘bed and breakfasting’ rules apply. 

     Of course, you might wonder how HMRC could possibly prove your intentions, but any patterns of repeated withdrawals or similar sums being withdrawn could be interpreted as an intention.

     Given the complexity of these rules, we recommend you speak to one of our expert accountants about the most efficient way to repay a director’s loan.

    Written off loans

    If your company writes off a director’s loan, there are tax and accounting implications that need to be considered. We recommend you speak to an accountant to decide on the best course of action for you and your business.

    Do HMRC monitor director’s loans?

    Indeed they do – and they’ll monitor DLAs which are regularly overdrawn through the company's annual tax returns. Be aware that they may decide that the money is not a loan but a salary, and subsequently charge Income Tax and National Insurance on the sum. We suggest that you monitor your director’s withdrawals to ensure you don’t exceed the £10,000 threshold.

    Directors should be aware that if too much money is borrowed and the company is unable to pay its creditors, the company could be forced into liquidation and the liquidator can take legal action against the director to collect the debt.

    Our advice comes from our team of accountants but it’s always best to get specialist help from your accountant when dealing with things like director’s loans, so you know you’re always on top of the law and not liable for hefty fines. With Crunch, you’ll get access to our team whenever you need it.

    Directors’ responsibilities

    This no-nonsense guide gives new directors’ of a limited company a clear and easy to understand overview of their responsibilities, duties and obligations towards their new business. You’ll also learn handy tips on how to run a successful, smooth and profitable operation.

    Discover your responsibilies as a director