If you have just started up a limited company, the director’s loan account can be one of the trickiest concepts to get your head around. But I promise you it’s not impossible. It is necessary in understanding how you relate to your company and more importantly, how you can get at your lovely profits.
- What isn’t a director’s loan
The director’s account is not a real bank account. The company may have a business bank account and you may have a personal bank account but these are both different from a director’s account.
- What is a director’s loan
The director’s account is a virtual account that exists only in your accounting records as a way to keep tally of the flow of money between you as an individual and the limited company.
Unlike a sole trader, when you set up a limited company, the company is separate from you as an individual (otherwise known as separate legal entity). Money earned by the business belongs to the company and not to you personally. However, there are various ways that you can take this money out and the director’s loan account keeps track the interactions between you and the company.
- Putting money in
There might be times when the company cash flow needs a helping hand from your personal funds, in the early days or if things are tight. When you do this you are making a loan to the business. If you put £1000 of your personal money into the company bank account, then you would also have £1000 owed to you by the company in the director’s account.
You don’t even have to be putting money into the company bank account to be making a loan to the business. If you have bought items for the company with your own money, then you have made a loan to the company and the value of the items would be recorded in the director’s account as money owed to you. Be a little careful if you are paying for travel and subsistence expenses with your own money and then claiming it back, as it could have implications for your personal tax.
You don’t even have to be spending money to be making a loan to the business. If you have a payroll you may be putting through a monthly directors salary. When cash flow is a bit tight and you choose not to pay yourself you are still owed that money. You have lent your salary to the business and the value of the salary payments would be recorded in the director’s account as money owed to you.
The important thing to remember is that you can take back this money at any time, provided the company has enough funds. When you lend money, you are a creditor to the business and like any other creditor, you can take repayment of your loan. However, you should not treat yourself more favorably than any of the other creditors. If you are repaying a loan then you don’t have to worry about dividends and you don’t have to pay tax on the money; these only become relevant when you are taking profit over and above what you have lent to the business.
- Taking money out
You can take money out of the company via dividends or via wages or, as mentioned above, to pay back a loan you have made. When you take money out of the company that is not a loan repayment, wage or dividend, then you are borrowing from the company via the directors loan. This might be personal spending on the business bank account, withdrawing cash for personal use or transferring money to your personal bank account.
In reality many directors borrow from the business during the year and then settle up at the year end by paying themselves dividends to clear off what they have borrowed. This is totally fine, but there are a few things to bear in mind.
- Things to watch out for
More than £10,000 – If the directors loan account is overdrawn by more than £10,000 (£5,000 in 2013-14) then it is classed as a benefit in kind because you are getting a loan without paying any interest. It must be declared on your personal tax return and you will have to pay income tax to equal to HMRC’s notional interest rate. To avoid this you can pay interest on your directors loan equal to or over the HMRC rate.
It’s not just you – As far as HMRC is concerned, the director’s loan also includes what it classes as associates, which can be a spouse or civil partner, business partner, relative, trustee, or a loan creditor. If the business is lending to someone closely connected to you or on your behalf it gets counted as part of your directors loan rather than a separate loan.
You owe the company money at year end – Dividends get paid after tax. So many people get caught out by this and end up without enough profit left over after tax to fully clear the directors loan account with dividends. Unfortunately, if you end up with owing money with an overdrawn director’s loan account (or in HMRC speak, a loan to participants) then you have to declare this on your corporation tax return and may have to pay some additional tax.
The good news – If you are able to pay back the overdrawn amount within 9 months and 1 day of your accounting year end then there is no tax to pay. You still need to declare the loan on the corporation tax return but you will get tax relief on the amount.
No bed and breakfasting – A proviso to this is that HMRC have now got wise to directors paying off the loan just before the 9 months and 1 day date and then taking it straight back out again the next day (what they call bed and breakfasting). If the amount repaid is then taken out within 30 days then this counts as if the loan has not been repaid.
The bad news – If you have not paid back the loan within 9 months and 1 day of the accounting year end then you will need to declare the loan on the corporation tax return and the company will have to pay tax on the loan amount. The current rate of tax on the director’s loan is 25%.
The better news so as not to end on a bad note – You can claim the director’s loan tax back once the loan is repaid via the corporation tax return, but not until 9 months after the end of the financial year in which the loan was paid off.
- Don’t forget
The director’s loan is not a real bank account, it is a virtual account that is the interaction between you and the company.
If you lend the company money then you can take it back whether or not the company is making a profit, providing there are enough funds available.
If you borrow money then make sure you don’t borrow more than can be cleared with dividends otherwise you’ll end up paying extra tax. Remember, dividends come after tax so when you work out how much money to borrow, you need to allow for the tax first.