What do you need to know about Director’s loans?

If you put your personal money into your limited company, or withdraw money for personal use and it isn’t salary, dividend or an expense repayment, it’s called a director’s loan.

You must keep a record each time you withdraw or put money into the business, and these transactions make up the director’s loan account.

Each director in the business has their own director's loan account, which is shown separately on the company's records.

The director’s loan account is used in the same way as a bank account, but shows how much the company owes to each director, or what the director owes to the company.

Using our bookkeeping service and a cloud accounting software, such as Xero, we will create a director's loan account for each director.

Director's loans can be used to loan money to the company, or borrow from the company.

Although the money that you borrow from your company as a director's loan can be used for anything, it's important to remember that there are serious tax considerations when you do this.

There's no legal limit on how much you can borrow as a director's loan.

However:

1. Consider how much you really need to borrow. If you borrow money that the company can't afford, it could lead to cash flow problems for the business.
2. If you regularly borrow money from the company, HMRC might decide that this should be treated as a salary, and ask you to pay income tax on it.
3. If the total amount of everything that you borrow is more than £10,000 at any one time, it will be automatically treated as a Benefit in Kind (BiK), more on this later.

You might pay for specific items for your company using personal money, or even put funds into the company to help it get started or grow.

You and your company are separate legal entities, so the money you put into the business is treated the same as any other loan, and the company owes it to you.

Your director's loan account should record every transaction which shows company money being withdrawn or used for personal reasons (that isn't a salary, dividend or expense repayment) or personal money being paid into the company account.

Recording your transactions

Your director's loan account transactions might be in the form of:

A cash transfer from the company bank account to a personal one, or the other way round.

Using a company card to pay for personal expenses. Using a personal card to pay for business expenses.

When you owe the company money

A debit balance on your director's loan account means that you owe money to the company. This should be repaid as soon as possible.

If the director is also a shareholder, this balance can be cleared as if it were a dividend, but only if the company made profits which allow this.

So, if the DLA is overdrawn by £5,000 (which means it would show a debit balance of £5,000), the company could declare dividends of £5,000 to clear the amount.

The director doesn't actually receive the £5,000 payment, but the 'transfer' is shown in the company's bookkeeping. The amount will be subject to dividend tax, which the director will have to pay personally.

The director's loan account will be credited with £5,000 to reduce the balance to zero.

Dividends will be debited with £5,000.

If you get to the end of your company's financial year and the loan amount hasn't been repaid or cleared as if it were a dividend, it might be subject to S455 Corporation Tax.

When the company owes you money

Director's loan accounts can work both ways, and you can lend your personal money to the business if it needs it.

If your director's loan account shows a credit balance, it means that the company owes money to you.

This might be start-up money to get the business going, or funds that you put in at a later date. The company won't have to pay Corporation Tax on the amount that you lend to it, and you can take the money back at any time.

Charging your company interest on a director's loan

The interest payments will be considered a business expense for the company.

However:

Your company will need to deduct 20% income tax when paying you the interest on the loan. These deductions need to be shown on a form called a CT61, and reported to HMRC every quarter.

The remaining amount will be paid to you but will be classed as personal income, so you'll need to include them on your Self Assessment tax return.

Ideally, if your director's loan account is ever overdrawn, you'll repay it before the end of the company's financial year.

There are tax penalties if you don't repay a director's loan within nine months and one day from the company's financial year end.

This is because the amount you borrowed hasn't yet been taxed, either through the company or your own tax return.

The way that HMRC deals with tax when directors take loans from their business depends on how much you borrow at any one time.

Tax you pay if your director's loan is less than £10,000

If the total amount you borrow as a director's loan stays below £10,000 in a financial year, then the tax that you pay depends on when you pay it back.

The key here is the nine months and one day window after the end of the company's financial year.

*If you pay back your director's loan within 4 years, the 32.5% corporation tax charge can be reclaimed by the company from HMRC.

If the total amount which you borrow from your company as a director's loan goes above £10,000 at any point in a financial year, it's automatically classed as a Benefit in Kind (BiK).

This means that both you personally and the company will be liable to pay tax on it.

The company must complete a P11D to tell HMRC about the benefit. The company will then pay Class 1A Employer's National Insurance on the total amount of the loan, at a rate of 13.8%.

You'll need to include the loan on your Self Assessment tax return.

What if I repay the loan before year end, then withdraw it again?

Paying your director’s loan back before the end of the financial year and then withdrawing it again after the year end has passed might seem like a great way to not pay any tax. It isn’t, this is tax avoidance.

Tax avoidance

To block directors from using their director's loan account this way, the government introduced a 30-day rule.

If you repay one loan to your company, you must wait at least 30 days before you're able to take out another one.

If HMRC decide that the way you repay and withdraw money to and from your director's loan account looks like tax avoidance - beware!

There'll be a bill for income tax and NI heading your way, and quite possibly some nasty tax penalties, too.