This guide describes how to operate your Director’s Loan Account (DLA). It provides practical guidance and other information about the tax implications for you personally, and your company, when you take money out of your business.
The legal position
It’s important to understand that your company is a legal entity and its affairs are quite separate to you personally. However, as a director, you have specific legal responsibilities to ensure your company complies with the relevant laws and other regulations published by the government. This includes guidance published by HMRC on tax matters.
Any profit (or loss) reported by your company remains the responsibility of the company to distribute (or make good), even if you are the sole shareholder and only director. You must operate the company's finances independently of your own.
What is a director's loan account?
HMRC regards the operation of the Director's Loan Account (DLA) as one of the riskier areas of your company’s affairs. The position of your DLA is reviewed closely by HMRC through annual tax returns to make sure your company is abiding by the rules.
Any funds you take out from your company, which is not a dividend or salary and exceeds the amount you have personally invested as a shareholder, is classified as a director’s loan. The amount must be recorded in your personal DLA and then paid back to your company.
Items you should record in your DLA are:
Any cash withdrawals from the company that you have made as a director
Personal expenses which were paid with company money
HMRC defines personal expenses as anything which is not wholly, exclusively and necessary for conducting your business.
You need to ensure your DLA provides a comprehensive record of all transactions involving your personal finances, and the company’s, to ensure it will stand up to scrutiny by HMRC.
How to repay a director’s loan?
You can repay or reduce a director's loan until the overdrawn DLA is cleared or reduced. You can do this by:
Issue dividends but don’t withdraw them as cash until the overdrawn amount is paid
Deposit cash into the business bank account
Pay business expenses from your personal resources
What happens if I don’t repay the director’s loan?
HMRC believes an overdrawn DLA provides company directors with an unfair tax advantage because they don’t pay any Income Tax on the amount overdrawn. It’s effectively a loan from the company to the director. The legislation is therefore in place to ensure tax is paid on the overdrawn amount.
When your company’s financial year ends and you have an overdrawn balance on your DLA, you must include the amount on your annual Company Tax Return. The overdrawn amount needs to be repaid within nine months and one day of the date of your company’s financial year end.
Tax implications of an overdrawn director’s loan account
If this isn't repaid by the above time period, your company will have to pay a penalty tax. For the tax years 2016/17 and 2017/18, this amount of tax is calculated as 32.5% of the overdrawn DLA amount. The penalty tax is set at the upper rate band for dividends for the tax year.
Once you’ve repaid the overdrawn DLA, you can reclaim any penalty tax you’ve paid on it. You have to make your claim to HMRC within four years of repaying the loan.
If you owe your company more than £10,000 and either no interest or a below market rate is payable on it, the loan is regarded by HMRC as a benefit in kind. HMRC uses a notional interest rate to calculate the amount of tax the company and the director should pay. For the 2015/16, 2016/17 and 2017/18 tax years, the interest rate used by HMRC is 3%.
Your company will need to record the benefit in kind on Forms P11D and P11D(b), as it will attract both income tax for the director, and National Insurance contributions (NICs) for the company’s employees.
The P11D form is submitted to HMRC and given to the relevant employee. They will use this when completing their Self Assessment, ensuring the correct amount of income tax is paid.
The P11D(b) form is submitted to HMRC and contains information on how much the company owes for employer’s NIC (Class 1A).
A director has an overdrawn DLA for 12 months. The amount overdrawn is constant at £12,000. HMRC will calculate that employer’s NICs is due from the company, and Income Tax is due from the director on the notional amount of interest which should be paid on the overdrawn DLA amount.
The notional amount of interest is set by HMRC for the year at 3% of the overdrawn DLA amount - so 3% of £12,000, which is £360. This is called the cash value of the benefit in kind.
The tax payable is:
If the director’s marginal Income Tax rate is higher than the standard rate, more tax is payable.
The director must include the cash value of the benefit of £360 on their annual self assessment.
Bed and Breakfasting
The government has taken steps to stop directors using an approach to reduce the amount of tax they pay. The approach is known as Bed and Breakfasting and means directors look to repay their overdrawn DLA amount before the year end to avoid any tax. At the start of the new tax year, they immediately put their DLA back into an overdrawn position with no intention to repay the amount permanently.
HMRC has put legislation in place which means where a director’s loan of £5,000 or more is repaid, a period of 30 days must pass before this amount can be taken out of the company again.
If the director makes any cash withdrawal from the company within the 30 day period, which is not linked to a dividend issued by the company, HMRC rules state that the loan has not been repaid regardless of the amount of the cash withdrawal - whether that's £10 or £10,000.
ABC Ltd is a close company with less than 4 shareholders in which Mr A is a director. The company’s accounting period ends on 31st March 2016.
On 25th March 2016, Mr A borrows £15,000 from ABC Ltd. If the loan is not repaid within nine months and a day of the end of the accounting period (by 1st January 2017), ABC Ltd must pay a penalty tax at 32.5% of the amount of the loan (£4,875).
On 1st December 2016, a dividend of £9,000 is declared by ABC Ltd on which Mr A must pay income tax. On the same day, Mr A repays the remaining £6,000.
On 10 December 2016, Mr A borrows £3,500 from the company. On 15 December 2016, Mr A withdraws a further £2,000 from the company.
Therefore £5,500 (£3,500 & £2,000) of the £6,000 repayment is matched with the £5,500.
This means only £500 of the £6,000 original loan has been repaid and so a penalty tax of 32.5% of £5,500 still applies.
What If your company owes you money?
If you put your own money into your company, you’re allowed to withdraw the amount at any time and there are no Company Tax implications. You can’t withdraw the amount you paid for your shares as this forms part of the equity of your company.
If you give your company a loan with interest, then this interest must be declared as income on your Self Assessment and you'll be taxed your marginal rate.
Written off loans
If your company gives you a director’s loan and then writes it off, the loan will then be treated as personal earned income. You’ll then be charged Income Tax by HMRC at the same rate as dividends are taxed. This is recorded in your Self Assessment in box 13 of the additional information form (SA101).
As you can see, the rules surrounding the operation of your director’s loan account are complex, especially if you are regularly overdrawn.
We strongly recommend you monitor your withdrawals from your company to ensure you do not inadvertently breach HMRC rules, especially the £10,000 threshold at your company’s year end.
To check the position of your DLA, navigate to the Pay Yourself tab in your Crunch account and check your Outstanding amount to director. Call your client manager if you have any queries.