Director’s loan accounts (DLAs) are a common source of confusion for many UK company directors. This article explains what a director’s loan account is, how it works, and the tax implications you need to be aware of.
DLAs can have significant tax consequences for the company and the director in certain circumstances, so understanding the rules is essential.
What Is a Director’s Loan Account?
DLAs are frequently used in owner-managed businesses for various reasons. However, care must be taken to ensure compliance. Typical scenarios include the following:
Temporary Personal Borrowing
One of the most common uses of a DLA is when a director borrows money from the company to meet short-term personal cash flow needs or to pay unexpected personal bills. In many small companies, directors draw regular monthly amounts in anticipation of future dividend declarations. These drawings are treated as loans until a dividend is formally declared and documented.
While this provides quick access to funds, it is still a borrowing that must be repaid. It carries potential tax risks if not managed properly and should ideally be reserved for emergencies and not used as a routine source of income.
Paying Company Expenses Personally
It is common for directors, particularly in start-ups or companies with tight cash flow, to use personal funds or credit cards to pay for business expenses. These amounts are credited to the director’s loan account to show that the company owes the director money. This is a legitimate use of a DLA, and the director can withdraw the same amount from the company tax-free as reimbursement.
Lending Money to the Company
Directors may loan their own money to the company, whether to provide start-up capital, purchase assets, or support the business during difficult periods. This creates a credit balance in the DLA, as the company owes the director. Compared to investing via share capital, this can offer advantages such as flexible repayments and the ability to charge interest.
DLAs are common in small businesses, but that does not mean the rules can be ignored. Taking money from your company that is not wages, a dividend, or a reimbursed business expense counts as a loan. You must keep proper records and follow the tax rules.
Record-keeping and Managing the DLA
HMRC expects companies to maintain accurate and up-to-date accounting records, particularly in relation to transactions between directors and their companies. Poor record-keeping can lead to disputes with HMRC and potential penalties.
Setting Up Your DLA Records
Each director should have their own separate DLA in the company’s records. You can manage your DLA through:
- Accounting software: Most packages allow you to set up a DLA as a nominal account. For example, Xero lets users set up a DLA for each director.
- Spreadsheet tracking: A simple spreadsheet can effectively track DLA transactions for smaller companies.
What to Record in Your DLA
All the following transactions should be documented in your DLA:
- Cash withdrawals from the company for personal use
- Personal expenses paid using company money or credit cards
- Cash loaned to the company
- Business expenses paid using personal funds
- Dividends declared but not yet paid
- Salary owed but not yet paid
Shareholder Approval Requirements
Under the Companies Act 2006, shareholders must first approve any loan of over £10,000 to a director. This rule still applies even if the director owns the company. It exists to ensure the business is run correctly and transparently.
Tax Implications
If the Director Owes the Company
If your DLA is overdrawn at the end of your company’s accounting period and is not repaid within nine months after the end of that period, a Section 455 tax charge may apply.
S455 Tax
S455 tax is a specific type of Corporation Tax payable by the company, not the director. It is designed to prevent directors from extracting company funds tax-free indefinitely through loans. It is a deterrent against using loans as a substitute for salary or dividends.
The tax applies if a loan made to a director remains outstanding nine months and one day after the company’s accounting period ends. The charge is currently 33.75% of the outstanding loan balance at the deadline.
The S455 tax is unusual because it is temporary. Once the director repays the loan in full, the company can reclaim the S455 tax it paid. However, the reclaim can only be submitted nine months and one day after the end of the accounting period in which the repayment occurred.
Benefit in Kind (BiK)
If you borrow over £10,000 interest-free or at a rate lower than HMRC’s official interest rate, the value of the interest saving is treated as a Benefit in Kind and is subject to income tax via a P11D form. The company may also have to pay Class 1A National Insurance on the benefit.
If the Company Owes the Director
In this case, there are no direct tax implications. However, the director may:
- Charge the company interest, which is declared as personal income
- Choose to repay the loan
- Convert the loan into shares via a formal process
This can be useful for improving cash flow or demonstrating investment in the business, particularly in early-stage start-ups.
How to Repay or Clear a Director’s Loan
There are several ways to repay an overdrawn director’s loan account:
- Cash repayment: Transfer personal funds back into the company account.
- Salary or dividend: Use your salary or a dividend to offset the debt, assuming the company has sufficient retained earnings for the dividend.
- Write it off: The company can forgive the debt, but HMRC treats this as income to the director, meaning tax will be due. The company can reclaim any Section 455 tax paid, but only after the required time has passed.
Avoiding Bed and Breakfasting
Some directors try to avoid the S455 tax by repaying the loan just before the nine-month deadline and then withdrawing the money again shortly afterwards. HMRC has anti-avoidance rules to prevent this, known as bed and breakfasting.
If you repay £5,000 or more and then take out a similar amount within 30 days, HMRC ignores the repayment for tax purposes.
Risks and Mistakes to Avoid
Overdrawing Without Understanding the Consequences
Many directors withdraw money from their companies without fully understanding the tax implications, especially the Section 455 charge and Benefit in Kind rules.
Poor or Incomplete Record-Keeping
Inadequate records of DLA transactions can lead to HMRC disputes and potential penalties. HMRC expects companies to maintain detailed records of all money flowing between directors and the company.
Treating the Company Bank Account Like a Personal One
A limited company is a separate legal entity. Regularly using the company account for personal expenses without proper documentation creates tax risks and may cause issues if the company encounters financial difficulty.
Missing Repayment Deadlines
Failing to repay overdrawn loans within nine months of the company’s year-end will trigger the Section 455 tax charge. Plan your repayments carefully to avoid this extra cost.
Repeated Borrowing and Repaying
Frequently borrowing from and repaying the company can trigger HMRC’s anti-avoidance rules. If HMRC suspects you are using the company as a personal bank account, it may investigate further.
When to Get Professional Advice
While this guide covers the key points, professional advice is strongly recommended in some situations.
- When engaging in complex tax planning involving director’s loans
- If you intend to charge interest on loans you have made to the company
- When your company is facing cash flow difficulties and considering internal loans
- Before deciding to write off a director’s loan due to the associated tax implications
A qualified tax adviser or accountant can help you make informed decisions and avoid costly mistakes.
Summary
A Director’s Loan Account is an essential financial tool for limited company directors. It offers flexibility but requires careful management to avoid tax issues. Remember the following key points:
- Maintain accurate and up-to-date records of all transactions
- Understand the tax implications, particularly the 33.75% S455 charge on overdrawn loans
- Plan repayments strategically and be aware of anti-avoidance rules such as bed and breakfasting
- Consider all options for clearing loans, including cash repayment, salary offsets, dividends, or loan write-offs
- Review your DLA regularly with your accountant to stay compliant and optimise your tax position
By understanding and properly managing your director’s loan account, you can maintain a clear separation between personal and company finances while making the most of the flexibility a limited company structure offers.
