There are various legalities that all directors and limited company owners should consider to prevent HMRC investigations and penalties.
Director’s loan accounts require extensive research before loans are taken – and tax should always be considered.
Keep reading to learn more about directors loans, why people take out directors loans, and what DLA’s (directors loan accounts) mean for tax.
What Is A Directors Loan Account?
A directors loan account (aka a DLA) is essentially a record of transactions taken from the company that’s neither a salary, dividend, expense payment, or owed to the company or director, or owed by a director to the business (aka overdrawn loan account).
All directors of a company should have a DLA to monitor funds to and from the company account.
Funds kept in a limited company bank account belong to the business, but directors can make withdrawals from the bank account using a director’s loan.
This means that if you have paid business costs using your personal funds, then you can retrieve the money back to yourself from the business account.
Any other withdrawal from the account must be documented in your personal director’s loan account.
When the financial year of the company ends, then the money you owe (or that you’re owed) will be recorded as either an asset or a liability in the company’s annual records.
A DLA can keep track of cash withdrawals that a director has made, as well as personal expenses paid using company funds.
Any business expenses should be purely for the purpose of business – if you spend money using the company account for personal use, then this would count as a personal expense.
Failing to record certain withdrawals, or falsely classing personal transactions as business expenses can be detrimental to yourself or your business, and result in an investigation.
If you owe the company over £10,000, then the loan will count as a benefit in kind – so should be accurately recorded on a P11D. This means that the funds will be taxed on both personal and company tax.
It also means that the company will be required to pay Class 1A national insurance on the full figure at 13.8%.
It’s a general rule of thumb that any loan over £10,000 should have shareholder approval beforehand. However, in many cases, the director will be a shareholder – so will often be a formality rather than a legal requirement.
Why Take Out A Directors Loan?
There are various different reasons why directors may take out a directors loan. One of the main reasons is wanting to borrow money from the business.
If you’re a company director and you need to solve a temporary cash-flow issue for personal reasons, you could use a DLA.
Many businesses also pay directors partly through the payroll (often up to the national insurance threshold) and then pay the rest via dividends. These should be correctly declared and paid using the company’s reserves.
What Does It Mean For Tax?
If your DLA is in credit, then the company owes you money and you won’t have to pay tax on it. However, if your account is in debit, then your director’s loan account is overdrawn, meaning that you’re in debt to the company and you will need to pay tax.
If your DLA is overdrawn by the end of the year, then you must pay the money back to the company by the limit set by HMRC.
Any overdue payments of directors’ loans result in the company paying an extra corporation tax (at 32.%) on the amount owed.
The APR is paid back to the company by HMRC when the director repays the funds owed. If the director doesn’t repay the loan, then the 32.5% will be owed by the director as personal tax.
There have been measures put in place to prevent directors from using DLAs to avoid tax – aka ‘bed and breakfasting’.
Some directors had previously repaid borrowed funds to the business before the year ended to avoid paying tax, and then taking the loan out again without actually paying the funds back.
To prevent directors from cheating the system, directors can’t take a loan of over £10,000 more than once a month.
