Directors Loan Account – One of the greatest mysteries of owning your own company for a lot of owner managers

When you first set up your Limited company you will usually need to put money into the company bank account to start trading before the cash rolls in from those initial sales.Where this money is accounted for is called the Directors Loan Account.

The basics

A limited company is a separate legal entity in its own right, and you shouldn’t be treating the company bank account as your own personal bank account.  All the income from trading should flow in and the purchases in the course of trade should of course be paid out of here.  In HMRC’s eyes all those purchases have to be “Necessary AND Wholly and Exclusively for the use of the Business”. 

You wouldn’t believe the numbers of times since running my own business, that clients have told me, that a hotel bill in the middle of August for two weeks with spa treatments and children’s meals and drinks is for visiting a client.  Or a trip to MacDonald’s is for travel and subsistence when visiting a client.  However the receipt show 2 big mac’s and 3 children’s meals and drinks.  HMRC would not wear either of these two scenarios on the rule above. 

The facts

If you take MORE money out of a company than you have put in – and it isn’t salary or dividend – it’s called a director’s loan.  Let’s recap……You and the company are totally separate.  The company’s money is not your money!  If your company makes a loan to any of its directors, then you must keep records of these director’s loans.

• A lot of people forget that each time they take money out of the ltd company bank account to pay for anything personal or just to put into your bank account (a bonus, undeclared “dividend” that the accountant will sort at the end of the year etc.) this may result in an overdrawn loan account.
• HMRC do not take to kindly to you having the benefit of an interest free loan from your company and unless you pay the money back (promptly) both you and the company will be penalised.

The Impact on you!

If you have a director’s loan account and the loan account balance is greater than £10,000 (you owe the company) at any time during the year HMRC will charge you tax on the benefit of having an interest free loan during the tax year!  This benefit will need to be declared on a P11d.  This figure was £5000 but was increased a couple of tax years ago.

HMRC will compute the interest based on what you would have paid had you had an equivalent loan from a third party.  HMRC use their own interest rates which are published on their website.  So for an overdrawn loan account of £10,000 for the whole of a financial year you would pay 3% interest as that is the current HMRC rate.  For a list of all the rates directly from HMRC click here HMRC official rates for Beneficial Loans

So £10,000 * 3% =£300

This would need to be declared and paid on your self-assessment tax return.

The simplest way for you to avoid this charge is not to have your director’s loan account go overdrawn by more than £10,000 at any time during the tax year.

The Impact on the Limited Company

HMRC will charge the company corporation tax at 32.5% on the balance of any director’s loan made to you which is still outstanding 9 months and one day after the end of the accounting period – this applies even if the loan is less than £10,000.

Let’s look at an example: –

Year end is 31^st July.  The company is owed by you £10,000 at year end and 9 months and 1 day later it is still outstanding i.e.  1^st May.

The company will be taxed on £10,000 at 32.5% = £3,250.

This tax is repayable when you repay the loan to the company – but there could be a significant time lag before HMRC pays you back!

This article is for general information only and no action should be taken, or refrained from, as a result of this information.  Professional advice should be taken based on specific circumstances in each individual case.  Whilst we endeavour to ensure that the information contained in the article is correct, no liability  will be accepted by KMA Accountancy which is a trading name of Kim Marlor Associates Ltd or damages of any kind arising from the contents of this communication, or for any action or decision taken as a result of using any such information.

Tags: Directors Loan Account, Small business, Small business reporting