When you need to access money in your Limited Company’s bank account, a Director’s Loan may well be an option.
A Director’s Loan allows you to borrow money for personal use without deducting it from your income, dividends, or business expenses. It’s not as simple as just withdrawing money from your account, though, and there are rules to be aware of.
What Is a Director’s Loan and How Do They Work?
There are two types of Director’s Loan: one in which the director borrows money from their own limited company, and the other in which the director lends money to the company.
A Director’s Loan occurs when money is taken from the company for reasons other than paying salaries, dividends, legitimate business expenses, or repaying money lent to the company.
Alternatively, the director can lend money to the corporation. This is common when the company’s director pays for the initial start-up costs of the business.
Another example is when a director invests their own money in the company to help it survive a period of financial hardship. Money can be repaid to the director tax-free at any time in these circumstances.
Taking out a Director’s Loan can provide you with funds in addition to your income and/or profits. In addition, short-term or one-time expenses, such as unanticipated payments, are often covered by them.
However, because they require a lot of paperwork and come with risks (such as the possibility of steep tax penalties), they should be saved as an emergency income source rather than used regularly.
Taking out a Director’s Loan may appear to be a much better alternative than taking out bank debt at first because of the convenience and flexibility with which it can be issued.
However, it should be carefully considered, as it can lead to heavy taxation for both the director and the company if the terms of the loan do not comply with HMRC’s rules.
There are no restrictions on how you can use a Director’s Loan. However, it should only be used as a last resort for short-term debt.
What is a Directors’ Loan Account?
A Director’s Loan Account is a record of all transactions between the business and the director. It keeps track of what the directors owe and what is owed to them.
The company’s yearly financial statements must document and account for this loan. This file is sometimes referred to as a ‘director’s loan account.’ The figures are reflected in the balance sheet as an asset (funds owed by the director) or a debt (funds owed to the director).
How to Take Out a Directors Loan?
Obtaining a Director’s Loan is not as simple as withdrawing funds from the company’s account. First, you must obtain the approval of the company’s shareholders — especially if the loan exceeds £10,000.
You must formally disclose the details of any credit granted by the company to its directors. This includes stating the amount granted during the year, the interest rate, the main condition, and any amounts repaid or written off.
This information should be written down for the company’s board minutes, and the shareholders must approve the process before it can be issued.
This can be a simple administrative job if you are the sole director of your own limited company with no other shareholders. Nonetheless, this step and updating the Director’s Loan account must not be overlooked.
What Happens to a Directors Loan Account in Liquidation?
A company may attempt to reduce or clear the Director’s Loan account by voting the outstanding amount as a dividend. However, if the company goes into insolvent liquidation, it may jeopardize both the company and the director.
For the benefit of the creditors, the liquidator will demand that directors repay their debt to the company. Legal action can be taken to force directors to pay this, which may result in personal bankruptcy.
The liquidator may investigate your personal finances to determine whether you can afford to repay the loan. It is the liquidator’s responsibility to see that the loan is repaid.
If you cannot repay the debt, you may be forced to declare personal bankruptcy. Furthermore, the insolvency practitioner is responsible for investigating your behaviour as a director before the insolvency or the company’s liquidation. As a result, you could be prohibited from serving as a director of any company for up to 15 years.
The safest approach to pay yourself as a director is through PAYE; the riskier option is to take drawings and hope that the business generates enough money to pay a dividend that covers the loan every year.
So, what should you do if you’re worried about your business being liquidated and you have an overdrawn account? You must obtain professional help as soon as possible to determine your best options.
How Much Can You Borrow?
A Director’s Loan can be used to borrow unlimited money. This means there is no limit. However, you should consider how much the company can afford to lend you. The last thing you want is for your business cash flow to suffer due to the loan.
When it comes to taxes however, there are some guidelines to follow. Your Director’s Loan will be classified as a benefit if it exceeds £10,000. This means you must file a P11D form with HMRC and declare it on your Self-Assessment tax return. You may also be obligated to pay tax on the loan.
Although there are no legal restrictions on how much you can withdraw from your business, there are many factors to consider when selecting how much to borrow.
How Do I Repay a Directors Loan?
The simplest way to repay a Director’s Loan is to transfer the funds back into the company’s bank account via a dividend payment or salary.
- Dividends: As a company director, you have the authority to pay dividends as frequently as you like. You may wish to withdraw dividends and use them to repay the DLA instead of paying them to your personal account.
- Salaries are still considered a legitimate business expense even if the company’s profits aren’t strong enough to pay dividends. Directors typically receive a salary in addition to dividends, which you can use to pay off the DLA.
- Cash: Repaying a Director’s Loan from your own personal account is desirable. This shows HMRC that you have made a genuine repayment separate from the company’s finances.
How to Claim Back a Directors Loan?
When a director lends money to the company, they can claim it back tax-free at any time. It does not have to be taken out as an income or dividend; it can simply be taken out of the account if recorded correctly. If the director charged interest on the loan, this can be written off as a business expense, lowering the corporation tax.
Any interest received by the director, on the other hand, must be reported as income on the director’s self-assessment tax return.
Contact us if you are having difficulties with an overdrawn DLA or determining what tax needs to be paid.
Directors Loan Account In Credit or Debit?
A Director’s Loan account can be either credit or debit. The company owes you money if the account is in credit. If it’s in debit, you owe money to your company.
Companies frequently borrow money from their directors, especially when a business is starting up or a director is lending the company money to help it develop. In most circumstances, it makes significantly more sense to fund a business with loans that are returned rather than paying them in with additional shares.
On the other hand, company directors are frequently funded by taking out loans from their companies. A loan is granted and repaid to the company through the distribution of salary, expense reclaims, and paying dividends.
What is the Interest Rate on a Directors Loan?
A Director’s Loan has no fixed interest rate, and the rate you charge is entirely up to your firm.
If, on the other hand, you choose to charge a little under HMRC’s official rate of interest – which is currently 2.25% and fluctuates in response to changes in the base rate – then the discount granted to the director may be considered a benefit in kind and should be recorded on your self-assessment.
If this occurs, you may be subject to the tax on the difference between the official rate and the rate you actually pay. In addition, class 1 National Insurance contributions will also be due at a rate of 13.8% of the loan’s total value.
What is an Overdrawn Directors Loan Account?
To put it simply, an overdrawn DLA is simply an unpaid Director’s Loan. It is popular for limited company directors to withdraw money from the company in ways other than a dividend or wage.
If they do, whatever money they take is deemed a loan from the business, and it must be repaid just like any other debt. This account must be rectified and paid within nine months of the end of your Corporation Tax accounting period, or tax will be due.
Having a Director’s Loan account in debit is not a problem as long as the balance is repaid within nine months of the accounting period.
When a Director’s Loan is not repaid within nine months of the company’s year-end, or, even worse, when the company begins to perform poorly and becomes insolvent, problems arise. As a result, the account becomes overdrawn.
If you have a Director’s Loan account that has become overdrawn, you must show the amount owed on your company tax return. Any amount that has not been repaid nine months after the end of your accounting period will be subject to Corporation Tax.
As part of a Corporation Tax compliance check, HMRC can question you about the presence of a director’s loan account at any time, so ensure you include all entries correctly.
Can a Directors Loan for a Company be Written Off?
The company may write off a loan made to a director. The amount written off is taxed as a deemed dividend. Because it is a deemed payout, there is no necessity for the business to have accessible profits for distribution, and the dividend does not have to be paid to all shareholders of a specific class of shares.
The loan amount that was written off must be included in the director’s Self-Assessment tax return. The business will not get Corporation Tax relief on the amount of the debt wiped off.
A DLA may be written off in the following circumstances:
- If a company has less than five shareholders (with the director being one of those shareholders). The loan is marked as a profit distribution in this case. If the loan is not transferred to another participant, the remaining amount is taxed as employment income and must be reported on the borrower’s tax return.
- The DLA can be decreased by voting the leftover funds as dividends or rewards – however, this will not apply if the company is about to enter insolvency.
- Personal liability from a Director’s Loan might be lowered for valid reasons, such as travel or personal costs used to purchase business assets.
Do You Pay Tax On an Overdrawn Directors Loan Account?
The amount you borrow and how long it takes to repay the money will determine whether or not you have to pay tax on your Director’s Loan.
You won’t have to pay any tax on the loan if you borrow less than £10,000 and repay it within nine months and one day of the company’s financial year-end date.
If the money is not repaid within nine months and one day of the firm’s year-end date, the company will be required to pay 32.5% of the outstanding loan total in Corporation Tax. You’ll also have to pay the interest on the Corporation Tax. This is intended to deter business owners from abusing director’s loans.
The Corporation Tax can be reimbursed nine months after the accounting period if the loan was repaid. The interest on the S455 tax, on the other hand, cannot be reclaimed; therefore, paying off the director’s loan within nine months and one day of the company’s financial year-end date is always the best option.
The director’s debt can be cancelled if the firm agrees it does not need to be repaid.
Written-off Director’s Loans must be reported on the director’s Self-Assessment tax return and may be subject to income tax. In addition, the company will also be required to pay Class 1 National Insurance contributions.
Final Notes on Loans to Company Directors
A Director’s Loan account allows a director to borrow from and lend money to the company. When a director withdraws funds, it should always be detailed and well-documented to prevent borrowing from spiralling out of control without a structured plan to repay the loan.
A director is solely liable for any funds taken from the company, and it is their responsibility to return them. For example, if the company goes bankrupt and there is an overdrawn director’s loan account, the director must repay it because it is an asset of the company.
If you have a director’s loan account and are concerned that your company is in financial trouble or is on the verge of insolvency, we can help. Future Strategy will be able to answer your questions and discuss your options on what would be most beneficial to you moving forward.