Running a business isn’t always easy work, especially when balancing the day-to-day business tasks with managing finances. You may find from time to time that you need to lend money to your company or even borrow money from your company – this is what is known as a director’s loan.
A director’s loan is one of the many perks of running your own company, acting as a flexible financial tool by allowing you to lend money to your company or borrow money from it. It can solve short-term cash flow needs, cover unexpected personal expenses or provide quick investment funding.
With over 30 years of dedicated experience in tax advisory and accounting, our family-run accountancy agency, Archimedia Accounts, is here to guide you through the complex topic of director’s loan accounts. We’ll delve into the income tax implications, Corporation Tax considerations and how to strategically use a director’s loan account to lend and borrow money within your company.
Keep reading our insightful blog to find out more, or get in touch with us today for personalised advice.
What is a director’s loan account (DLA)?
A director’s loan account is a specific financial record that tracks how much money you borrow from your company and how much money you lend to your company. It is used to monitor the flow of funds between a director and their business, ensuring transparency and accountability.
Want to know more about how a director’s loan account works, take a look at our recent video below:
Types of directors’ loans
There are two types of director loans: one is when a director borrows money from the company, and the other is when the director lends money to the company.
Loans to a director
The first type of director’s loan is when the director takes funds out of the business, putting them in debt to the company. As a director, you may decide to take a loan from your company to cover unexpected personal expenses or fund new business opportunities.
When a director owes money to their company, it is known as an overdrawn director’s loan (or negative director’s loan). If there is sufficient profit in the business, then an overdrawn director’s loan account can be wiped away using dividends. You can also repay a director’s loan using your salary or personal funds.
It is extremely important to only borrow from your company to cover short-term expenses and have a clear plan to repay the overdrawn director’s loan. This prevents you from borrowing money you can’t repay, keeping you and your business financially safe.
Loans to the company
The alternative type of director’s loan is when the company owes money to the director. As a director, you can also lend money to your company to steady cash flow issues or support a fast investment opportunity. When the company owes you money, it creates a positive director’s loan account.
Additionally, when a director pays for business expenses personally (e.g. mileage), these expenses are treated as an expense on the profit and loss account and increase the funds owed to the director. This is because the cost of the expense was incurred personally by the director.
What are the tax implications of directors’ loans?
If the director has a positive director’s loan account, the director can take funds out of the company tax-free.
However, if the director has a negative director’s loan account, they may be expected to pay tax in certain situations. One way to avoid this is to reduce the overdrawn director’s loan account before the company’s year-end by distributing dividends (assuming there are sufficient profits to do so) or by increasing the director’s salary. Instead of the director receiving cash payments, they can opt to have them reduce their negative loan account.
A caveat to this is that the director will have to declare the dividends on their tax return and pay tax according to their personal tax brackets. Their salary will also affect how much personal tax they have to pay.
Tax and directors’ loans can be very complicated, but the most important thing to note is that you will only have to pay tax if you owe the company a significant amount of money. It is essential to repay the funds within 9 months of the year-end to avoid penalties, as HMRC don’t want companies to be in debt from the directors owing money.
If you find the tax implications of a directors’ loan account somewhat confusing, contact us today, and we’ll provide expert advice tailored to your business and situation.
Is a director’s loan liable to Corporation Tax?
If the director lends money to their company, then there will be no Corporation Tax due as the company will effectively be in debt.
However, suppose the director is in debt to the company and hasn’t paid back the loan during the accounting period before the company’s year-end, or the loan is more than £10,000. In that case, the company may be subject to Corporation Tax.
If the negative balance on a director’s loan is paid off during the accounting period, before the year-end, then there is no Corporation Tax payable (although there may be a benefit in kind in some cases).
When money is withdrawn from the company, do you have to pay income tax on a director’s loan?
There are times when Corporation Tax and personal tax are both liable on a director’s loan. As previously mentioned, this is usually when the director owes a significant amount of money but has not paid it back before the deadline. HMRC has additional advice for directors who owe their company money.
Does a director’s loan count as a business expense?
The loan itself does not count as a business expense; it is a loan to or from the directors. However, if the director incurs business expenses and pays for them personally, the cost is set off against income for Corporation Tax purposes.
The funds paid by the director are added to their director’s loan, increasing the funds they can take out of the company without paying tax.
What are the advantages of directors’ loans?
As a director of a limited company, you can use additional funds as you need to, provided there are sufficient funds in the business and you understand the legal and tax implications involved.
You also have the ability to charge the company interest when you provide funds to the business. However, you should be aware that as the director, you will have to pay income tax if the interest is more than £1,000 for a basic rate tax-payer or £500 for a higher rate tax-payer. On the flip side, the company will benefit from saving on Corporation Tax as the interest charged is a tax-deductible expense.
Ultimately, directors’ loans give a lot of flexibility to the directors.
At Archimedia, we often get asked questions by new directors, like “What happens if I buy something personally for the business?” or “What happens if I accidentally pay for some personal clothes with the company bank account?” or “Can I just take money out my business bank account?” The solution is easy, thanks to your director’s loan account. It allows you to manage the transactions between you and your business effectively.
What are the disadvantages of directors’ loans?
As with any type of loan, there can be some disadvantages to look out for, which are mostly centred around tax and fees.
The first drawback is the Corporation Tax due on any overdrawn directors’ loan account that has not been paid within the agreed timeframe. Plus, if a director’s loan is overdrawn, it can also be treated as a benefit in kind and, therefore, subject to income tax and National Insurance implications.
Another consideration is that directors can get into a vicious cycle of owing their company money that they can’t pay back. This not only causes financial strain on the company and its director, but it can also rack up some hefty tax bills.
With a good accountant by your side, like the expert team at Archimedia, you will always be made aware of any dangerous financial situations that may loom.
Get in touch with Archimedia Accounts today
If you’re thinking of borrowing or lending money within your company, then our dedicated team will help you do so in the most effective way possible. As part of our comprehensive limited company accounting services, we’ll provide strategic advice on utilising your director’s loans to best suit you and your company, all while considering tax implications and ensuring compliance.
Whether you’re looking to borrow money from your company to cover unexpected bills at home or want to lend money to the company to snap up a rare investment opportunity, our accountants are ready to help.
Get in touch today for a free consultation!