When you’re running a company, there are many pieces of legislation and accounting jargon that you need to be familiar with. Some of these you may have heard of but might not fully understand. One of the more technical items of tax legislation/jargon is a director’s loan account (DLA).
If you’ve heard of it but are still wondering what a director’s loan account is, keep reading as we explain everything you need to know about this piece of accounting jargon and how it might apply to you.
What is a director’s loan account?
Put simply, a director’s loan account (DLA) is a record of any money that a director borrows from or pays into their company. This loan is separate from the director’s salary and company dividends and would be used, for example, if the director lends their company money to fund day to day trading so that company does not need to liquidise assets.
In simple terms, a good way to look at it is as if you’re an employee who’s been asked to pick up some milk for the communal fridge. There’s no money in the petty cash which means you need to buy the milk using your own money. When you get back to the office, you present your manager with the receipt for the milk and they then pay you back.
This is essentially how director’s loan accounts work, but rather than being just an employee, you’re the manager in the situation, too. This means if you need to pay for something for your company using your own money and you’re the director, you can record it on the balance sheet within your director’s loan account.
As mentioned, DLA’s work the other way round, too. There may be some instances where a company director needs to borrow money from their company outside of their usual salary, expense payments, or dividends. This money is considered a loan and will have to be repaid. Instances such as this are recorded and repaid under a DLA.
In terms of who is eligible for a DLA, if you are a company director, you should be able to open a director’s loan account.
What is a director’s loan account example?
If you’re wondering what scenario may permit a DLA to be issued, here are some examples.
In the case of borrowing money from your company as a loan, this might occur if you have an unforeseen personal bill to pay that can’t be covered with your normal salary or dividends payments. In instances such as these, a DLA is seen as a last resort, largely because it incurs a massive amount of paperwork and admin and can also come with hefty tax penalties. This means using a DLA in this type of scenario is rare, but it does happen. If you’re thinking of doing this, beware of the tax penalties that may follow.
Another example of when a DLA may be used is if something needs to be purchased or paid for by the company, for example, a bill, or new software, but the money to buy it isn’t immediately available from the company. In this instance, a director may choose to initially foot the bill themselves and then be reimbursed by the company at a later date through a DLA.
What are the rules for a director’s loan account?
As mentioned, there are some important tax details relating to DLAs, as well as various other rules. They are as follows:
· Once a loan has been made in either direction, the DLA automatically becomes a listed company asset, so it is important to keep this record up to date.
· Larger loans to the director of over £10,000 may need stakeholder permission.
· If the loan is over £10,000, it is treated as a benefit in kind and national insurance is deducted.
· If you lend your company money and charge interest, you must declare the interest as income when you submit a self-assessment tax return.
How much can be borrowed as a director’s loan?
You might be wondering how much can be borrowed through a DLA and whether there are any legal restrictions on amounts that can be lent either way. In short, there are no legal restrictions on how much money you are allowed to borrow from your company or vice versa, but as mentioned, loans over £10,000 have to be declared on a self-assessment tax return.
How much interest can be charged on a director’s loan?
If your company lends money to you, they can decide independently how much interest to charge on the director’s loan. That being said, if the business decides to charge less than the standard rate of tax, the discount offered will be logged as a benefit in kind by HMRC which means you may face an additional tax charge payable on the difference between what is considered the standard rate and the rate you’re paying.
You should also note that 13.8% Class 1 National Insurance will be payable on the overall cost of the loan.
How quickly does a director’s loan need to be paid back?
Whilst there is no limit on how much money can be borrowed through a director’s loan account, there is a time limit on when it needs to be paid back – if you want to avoid a large tax bill, that is.
You will have nine months and one day to repay a DLA within a company’s year-end accounts reports. If you fail to pay back the DLA within that time, or if you’ve paid some of it but not all of it, you will be subject to the S455 tax. This is a hefty corporation tax bill of 32.5% on whatever is outstanding after nine months and one day of the year-end.
Can corporation tax be claimed back on a director’s loan?
It is possible to claim back the 32.5% corporation tax bill; however, it can only be done once the outstanding debt has been paid, and it can take a while to get the money back. Depending on your company’s financial situation, the added tax could cause cash flow problems, so it’s best to avoid it where possible and ensure all DLAs are settled before the nine months and one day cut off point.
If this isn’t possible, your company may decide to hold off paying its owed corporation tax until the director’s loan has been paid in full. Corporation tax is due nine months following the year-end, so this could potentially give you extra time to balance the books and zero out any owed debts.
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What happens when you have an overdrawn loan account?
A DLA becomes overdrawn if the company directors are borrowing more money from it than they are lending to it. In contrast, if the company is being lent more from its directors than they are taking from it, the DLA is considered to be in credit.
Having an overdrawn loan account occurs when the director is in debt to the company. This is not a problem provided that the director pays the company back within nine months and one day of their year-end. If the loan is not repaid within nine months, then it will be viewed as director income and is therefore taxable along those lines. If this happens, the company will be required to pay a corporation tax of 32.5%.
This is paid back by HMRC once the loan has been repaid and a claim for the refund must be filed within four years. However, it does result in a temporary loss of money for the company which is worth avoiding!
How do you repay a director’s loan?
There are multiple ways to repay a director’s loan. One way to pay the DLA back is by using dividends that the director receives at the end of the year. By paying back the DLA in this fashion, it means money does not need to be transferred in and out of the business and is a neater option. Equally, the director’s salary can also be used to pay off the loan, or the director can simply transfer money back into the company account at a suitable time.
Doing so will ensure the steep 32.2% tax fee is avoided.
Taking out multiple director’s loans
A common question surrounding director’s loans is whether one can be taken out immediately after one has been paid off. This is a potentially sticky area and one in which you need to tread carefully because HMRC may view it as if you are avoiding paying corporation tax, and this can lead to further issues down the line.
With this in mind, HMRC introduced a rule that states there must be a 30-day gap between one loan being paid off and another loan being taken out. Even then, if you routinely take out director’s loans, HMRC may still suspect tax avoidance, so it’s best to try and avoid taking out multiple director’s loans.
Can director’s loans be taken out inadvertently?
Many directors opt to get paid in the form of dividends due to the fact the tax contributions are more lenient compared to a salary; however, you need to be careful with this. As a company director, you’ll know that dividends can only be paid when a business has turned a profit because it is profits that pay dividends. If there are no profits, then dividends cannot be legally paid out.
With this in mind, if you don’t pay due diligence when preparing your accounts and mistakenly record a profit and pay dividends when there isn’t actually a profit, the dividend becomes illegal. In this instance, it will need to be considered as a director’s loan and will be subject to the nine months repayment deadline.
A brief summary of a director’s loan
There’s a lot to take in when it comes to director’s loan accounts, so we’ve put together a brief summary checklist on the key points about director’s loan accounts – whether you’re lending money to your company or your company is lending money to you:
· Director’s loans should be considered as a last resort and not be relied on regularly
· Director’s loans need to be paid back within nine months and one day of the company submitting its year-end to avoid the hefty corporation tax bill
· Loans exceeding £10,000 from your company to you must be declared on your self-assessment and regarded as a benefit in kind
· Do not take out dividends unless you are 100% certain your company has turned a profit
· You have to wait 30 days between paying off an old director’s loan and taking out a new one
· You should aim to refrain from an overdrawn DLA
· Consult with company stakeholders if you will be taking out a loan exceeding £10,000
Whilst directors’ loan accounts may not be the most exciting thing in the world, it is important to know how they work. We hope this has given you an insight into how to successfully use a DLA and repay a director’s loan.
In essence, a lot of the information regarding DLAs comes down to good bookkeeping and accounting. Accountancy Cloud can help you keep on top of your company’s finances, including any director’s loan accounts and outstanding loans, with our hassle-free integrated accounting software.
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