Director Loan Accounts explained
It is common for Directors of a Limited company to occasionally pay for business expenses from their own pocket or to lend the company money.
These transactions are recorded on the company balance sheet as Director Loan Account (DLA) and the company can pay the money owed back to the Director when cash flow and profits allow or vice versa.
Here are some examples to help explain it further:
Let’s say the company is struggling with cashflow and cannot pay its suppliers. You, the Director, could loan some money to the company to help it. You would transfer some money into the company bank account and it would be paid back to you at a later date when the company can afford it.
Another reason a Director might lend to the company is convenience. You might be in the supermarket doing your weekly shop and remember you need some stationery but don’t have the business card with you. You can pay for the stationery yourself and then record the cost on the company balance sheet as a director loan for the company to pay you back at a later date.
If a Director borrows money either by taking cash from the bank account or by using the company bank account to pay for personal items, this is called an “overdrawn director loan”. This is not something that we recommend you do.
It's important to note that a DLA can have tax implications for both the company and the directors. For example, if the directors borrow money from the company and the DLA isn't repaid within a certain time frame, it could be seen as a benefit in kind and be subject to tax. We’ll cover that in detail later.
What happens if a director lends money to the company?
If a director lends money to the company through a Director's Loan Account (DLA), there are a few things to consider:
Impact on financial statements: The loan from the director will be recorded on the company's balance sheet as a liability, just like any other loan. This can impact the company's debt-to-equity ratio and other financial metrics
Interest payments: You can charge interest on the loan you make to the company and the interest could be a tax deductible business expense. However, you would need to be able to justify the interest rate you use to HMRC and you may have to pay personal tax on the interest you receive and so charging interest is not always the best thing to do
Repayment terms: The director and the company can agree on the repayment terms for the loan or the arrangement can be more informal where the money is repaid to the director when the company can afford it. The director should consider carefully if the company will be able to repay the loan
Disclosures: If the total amount of outstanding loans from a company to its directors exceeds £10,000 at any point during the year, this must be disclosed in the company's annual accounts
In summary, lending money to the company through a DLA can be a useful tool for directors to support the company's financial needs, but it's important to understand the potential implications and ensure that the loan is properly documented and managed.
What happens if a director borrows money from the company?
We do not recommend directors borrow money from their company. Money should be taken from the company by either a directors salary, dividends or repayment of DLA if the company owes the director money.
S455 tax: If a director borrows more than £10,000 from the company through a DLA and does not repay the full amount within 9 months of the end of the accounting period, the company must pay a tax called S455 tax. This tax is currently set at 32.5% of the outstanding balance of the loan. The tax can be reclaimed by the company once the loan is repaid but can often take a long time and so this can create a cash flow issue for the company.
Benefit in kind: If a director borrows more than £10,000 from the company through a DLA and does not pay interest on the loan, the amount of interest that would have been charged is treated as a benefit in kind and is subject to income tax and national insurance contributions (NICs).
Dividends: If an owner-director takes “illegal dividends” - when there are not enough after tax profits available - the dividend must be reclassified as a director loan and paid back
Borrowing/ mortgages: If an owner-director applies for personal mortgage, the lender will often look at the company accounts. An overdrawn director loan can often cause difficulties in accessing a mortgage or other borrowing in the directors name as well as the companies name.
What are the benefits of a Director’s Loan Account?
There are certainly benefits to having a Director's Loan Account for both the directors and the company. Here are some potential advantages:
Convenient way to borrow money: If a company needs a short term injection of funds, using a DLA can be a convenient and straightforward way to do it. It allows the company to take out a loan without having to go through a formal application process or seek external financing
Flexibility: A DLA can be flexible in terms of the repayment terms. The directors and the company can agree on a repayment schedule that suits both parties, and this can be adjusted over time as necessary.
Interest & fee savings: If the company needs to borrow and small amount of money that the director is comfortable lending it can avoid paying interest and set up fees to a more formal lender
Cash flow management: A DLA can be a useful tool for managing cash flow within the company. In particular, a director may chose to loan money to the company to help it get started or during a quieter period
Are there drawbacks to a Directors Loan Account?
While there are potential benefits to having a Director's Loan Account (DLA), there are also some potential drawbacks that should be considered. Here are a few things to watch out for:
Tax implications: If a DLA is not managed properly, it can have significant tax implications for both the company and the directors. For example, if a director borrows money from the company and the DLA is not repaid within a certain time frame, it could be seen as a benefit in kind and be subject to tax. Similarly, if the company lends money to a director and charges little or no interest, it could be considered a taxable benefit.
Repayment uncertainty: If a DLA is not repaid on time, it can create uncertainty and tension between the directors and the company. We recommend directors carefully consider if they should loan money to the company. It is common for directors to feel personally attached to their company and continue to loan money to keep the company afloat without considering if the company is financially viable or if they will ever receive the money back
Legal issues: If a DLA is not properly documented or managed, it can lead to legal issues. For example, if a director is seen to be taking advantage of the company by borrowing excessive amounts of money, it could lead to accusations of misconduct or even legal action.
Creditworthiness: If a director borrows money from the company through a DLA, it may affect their personal creditworthiness if they are unable to repay the loan on time. This could make it more difficult for them to secure financing in the future or get credit on account with suppliers.
It’s important to ensure that the DLA is structured and managed properly and avoid these potential pitfalls and ensure it is advantageous to both the company and directors.
Can sole traders benefit from a Directors Loan Account?
Directors Loan Accounts are strictly for Limited Companies only. Limited companies are separate legal entities and so company money is separate to the owners' money. A sole trader's money is not separate and so it's not possible for a sole trader to loan money to themselves.
Getting more advice about a Directors Loan Account
It's important to note that tax rules and thresholds can change over time, so it's always best to consult with a qualified accountant before embarking on a DLA.
We offer a pre-year end review meeting to all our Limited Company clients who use cloud bookkeeping software (e.g. Xero). This includes a review of Director Loan Accounts so that you know where you stand and if remedial action is required to ensure you are on the right track.
We also offer our clients a Directors’ Handbook with guidance for Company Directors.
Get in touch with us today if you feel that this is the kind of support you need for your business.
Need some help to understand how this affects your business? Give us a call.
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