Clients often ask us to explain the Director’s Loan Account and provide information on when they might typically use it. In this article, we will share everything you need to know in our usual jargon-free way!
What is the Director’s Loan Account?
The Director’s Loan Account records the money the director or directors owe their Limited Company, or vice versa.
Having a Director’s Loan Account helps manage personal and business cashflow demands. If a director takes money from the company that can’t be classified as salary, expenses, or dividends, the transactions will sit in the Director’s Loan Account. It’s a way for a business owner to borrow money from the company. However, they need to repay it, and HMRC has rules about that…
The Rules!
The director should repay the entire balance of the Director’s Loan Account to the business within nine months and one day of the company year-end. If they don’t, they may incur additional corporation tax. The logic is that the director has taken money from the business that HMRC hasn’t taxed. So, HMRC will expect the company to ‘loan’ them what would be the tax on that money. When the director repays the loan, this loan tax is refunded.
HMRC considers an overdrawn Director’s Loan Account a ‘benefit in kind’ to the director. If the director owes more than £10k, interest-free, to the company at the year’s end, they must record the loan on their Director’s P11D, and the company would need to pay Class 1A National Insurance on the total amount.
If a director borrows more than £10k from the business, it may be necessary to record that all shareholders approved of this loan.
What is the Director’s Loan Account, and how does it work?
We thought it would be helpful to include some scenarios illustrating how the Director’s Loan Account operates in practice to help you understand it.
Example 1: If a director accidentally paid for a personal expense with a business card, they could repay it or post the expense to the Director’s Loan Account, showing that they owe it back to the business.
Example 2: If a business was short of cash for a period, the director could temporarily put money into the company, planning to take it back out soon. This would be posted to the Director’s Loan account, as would the repayment to the director.
Best Practices:
The Director’s Loan Account is a balance sheet showing the money owed to or from the director. The best practice is to review the balance of that account regularly. This could be part of the monthly financial review process.
The director is responsible for managing the Director’s Loan Account and ensuring compliance with any tax regulations. The director should always keep accurate records of transactions, including those on the Director’s Loan Account, and ensure that all transactions are documented appropriately.
Keep your accountant and bookkeeper informed about any planned use of your Director’s Loan Account. Then, they can advise you on any impact on your taxes and future planning.
Profits, Reserves, Drawings & Dividends:
At the end of the financial year, an accountant will determine your company’s profit.
If you have the profits and reserves in the business, you may declare a dividend to the Shareholders. You might use that dividend to clear the Director’s Loan Account. Many business owners regularly draw money from their business as a ‘dividend’. However, it’s only a dividend when the profit and reserves are agreed upon and a dividend is formally declared. Until then, the money taken from the business is classified as ‘drawings’ and sits in the Director’s Loan Account. The risk here is that if the profits aren’t there at the end of the year, the Director may have to return the drawings they’ve taken or face having to find additional money to front the tax payment to HMRC.
Keeping an up-to-date view of your accounts, particularly your profit or loss, can help ensure a director doesn’t take more out of the business than they would be due on a dividend at the end of the year.
If you have any further questions about the Director’s Loan Account, we are happy to answer them. Get in touch HERE.