What is a Director’s Loan Account? Tax Accountants Explain
Author: Russell SmithOctober 23, 2017
Not sure what a director‘s loan account is? Our expert chartered accountants tell you everything you need to know.
When you establish a limited company, you entrust the ownership of that business to somebody — or, in the case of a business partnership, multiple people.
The owner of a business can have any number of titles, usually CEO, chairman, or director. These are all effectively the same thing: a managing director of the company.
In a smaller business, the director likely has a much bigger role to play in terms of finances than in big corporations. The result is that, sometimes, the personal finances of a director become intertwined with that of the business.
When money is exchanged between the director and the business and it isn’t either a salary payment or a dividend, it is considered a director’s loan.
What is a Director’s Loan?
Salaries and dividends are how a director makes their living via their company. However, these are taxable incomes and, sometimes, are not appropriate for the activity being carried out.
For example, if a director were to buy a company car for the business and were to take the money owed for that car as additional salary, they’d incur large tax costs as a result. In this circumstance, the director has loaned the company money which it now owes back.
But the roles can also be reversed.
A director can use company money to buy their own personal vehicle. However, as long as they pay the company back with their own, already-taxed income, they won’t be charged additional fees for the privilege. The director then owes the company money.
This sort of activity must be monitored, following the regulations and rules set in place by HMRC. If these regulations aren’t followed, it would be all too easy for directors and companies to avoid proper taxation.
So, how do you make sure you stay on the right side of HMRC? A director’s loan account.
Accountants Explain Director’s Loan Accounts
A director’s loan account is essentially a balance account that monitors what a director owes or is owed.
It is separate from all other expense and income accounts, in that it is dedicated entirely to make sure the company keeps track of director’s loans. The purpose of this account is to ensure that accurate records are kept detailing every director’s loan.
Once it is time to submit your annual returns, you then combine your director’s loan account with your standard balance sheet. Ideally, though, you won’t have to do this, as you may end up paying tax on loans when filing your tax returns — more on this later.
When the Director Loan Account Owes You Money
It is quite common for a small business to owe a director money, especially in the early days. However, our tax accountants recommend keeping all expenses on business accounts where possible. It just removes any hassle.
Still, sometimes it is unavoidable. The business may not have the capital to purchase certain items required to run it, for example, which means the director pays with their own line of credit. The business must simply then repay the appropriate amount to the director when possible.
The biggest downside to a director’s loan at the expense of the director is that they are out of pocket until the business is able to raise the capital to pay off the loan. You also cannot claim the expense on your tax return until it has been paid off.
However, because no single person is profiting from this loan, you won’t face any wrath from HMRC for delayed payments. Not so when it comes to the director owing the business money.
When You Own the Director’s Loan Account Money
When the director of a company takes a loan from their own business, they become indebted to that business. On your director’s loan account, they (potentially you) will indeed be counted as a debtor.
A director’s loan can be given out for anything. You might need to buy a new car to get to work, or you might fancy a holiday to Aruba. That’s not a problem. The only problem is if you don’t pay it back.
If once the time for your annual return comes, the director is still indebted to the company, the director’s account is considered overdrawn and they will be given nine months to repay the loan by HMRC.
If, after that nine months, they are still indebted to the business, the director will be charged a 32.5% fee on the loan in line with current dividend tax rates.
Essentially, this means a director cannot get away with taking out an untaxed loan and dodgy dividend tax. There is a bright side: if you are able to pay this loan back, later on, you will be refunded the 32.5% fee.
There is another hitch, though.
If the director’s account is overdrawn at the end of the year, it is considered an outstanding loan and interest must be charged on it. As of the 2017/2018 tax year, this rate stands at 2.5%. This means the company must charge the director interest on their director’s loan.
Basically, you must charge yourself interest. Hurts, right?
One Final Note on Director’s Loans
Occasionally, you may need immediate payment for something. Perhaps you’ve had a sudden personal expenditure or you have to buy something important for the business immediately.
Directors have the ability to take out a director’s loan right away and then submit claims for expenses or dividends later on. Once these claims have been declared, the loan becomes either an expense payment or a dividend and the director’s loan account clears to zero.
Need help managing your director’s loan account? Our Leeds accountants know everything you could ever hope to know about managing director’s loans. Get in touch today and we’ll be on hand to support you and your business.