Director’s loan accounts - A guide for small companies

What is a director’s loan account?

If you run your own Limited company the phrase ‘director loan account’ has probably been thrown into conversation by your accountant, but what does the term actually mean?

In short, it’s simply a record of all the transactions between the company and you, its director.

The loan account (sometimes called a director’s current account) might include any, or all, of the following:

  • Money you have lent to the company
  • Money you have taken out of the company, which isn’t otherwise categorised
  • Salary due to you, but not actually taken from the bank
  • Expenses paid by you on behalf of the company which you’ve not been reimbursed for
  • Provisions for expenses, such as using your home as your office
  • Dividends declared to you but not paid from the bank account
  • Interest on the balance

What types of director’s loan account are there?

The transactions between you and the company are then tallied up and classified as either:

In credit

The company owes you money.

Overdrawn

You owe the company money.

Why would you loan the company money?

Often new businesses will need an injection of cash to get the business started, and as they are unlikely to qualify for a bank loan, loaning money from the director is a great way to access funds.

More established businesses may need a cash injection to assist with cashflow.

The good news is that you can withdraw any amount that the company owes to you without any tax implications whatsoever.  Just make sure that the company can afford to pay out other creditors such as suppliers and HMRC as well as repaying your loan.

But there’s more good news - the company can pay you interest on the money you loan to it!

This is a great way of extracting money from the company, in respect of a loan you have made to it.

The interest rate from you can be set higher than the business might commercially be able to get from a bank. This is because the bank would ordinarily be looking for security against assets or perhaps a personal guarantee, but as you’re not providing these, the loan would be classed as unsecured as it’s riskier.  We therefore suggest that a rate of 8-10% could be considered reasonable.

Note that it’s important to speak to us here as there is paperwork associated with this.  A declaration needs to be made to HMRC, as well as tax being deducted.  However, the great part is that if planned well it might also be possible to recover all or some of the tax deducted, as most UK individuals have a tax-free interest income allowance called a ‘Personal Savings Allowance’.

Are overdrawn director’s loan accounts bad?

With the right planning - not necessarily! 

Surprise overdrawn director loan accounts are usually bad news as there’s little planning that can be done by the time that they are discovered.  These often occur where you draw out more than you’re entitled to in salary or dividends, or if you use company money to pay for personal costs like holidays.

BUT a carefully planned director’s loan withdrawal can avoid costly and unnecessary tax implications and also be really helpful.  Say for example you need a short-term loan to pay your child’s university fees or put a deposit down on a house – the company could loan you the money.

Important points for taking out a director’s loan:

What if’s over £10k?

If the loan exceeds this amount HMRC consider it a ‘benefit in kind’, meaning you are getting the benefit of an interest free, or low interest loan that would not be available elsewhere.  This means that either the ‘benefit’ you are receiving becomes taxable, or the more common approach is that the company should charge you interest on the loan.  HMRC’s guideline rate for 2021/22 is a fairly favourable 2.25%.

When should it be repaid?

The loan needs to be repaid within 9 months (and 1 day) of the accounts year end to avoid an additional, albeit temporary, corporation tax charge of 32.5%.  However, it’s not necessarily the end of the world if this does need to be paid as the tax can be recovered from HMRC, once the loan has been repaid.  Just remember that it may cause a cashflow issue for the business in terms of paying out the additional tax and having to wait to claim it back.

How is a director’s loan repaid?

In cash

Repaying your loan could be as simple as depositing personal money back into the business account but don’t worry if this isn’t an option, there are alternatives.

Salary

It’s not the preferred way of making a repayment as it’s not usually tax efficient, but a salary could be declared via the company’s payroll scheme, which you do not then take from the bank. 

Dividends  

The most tax efficient way of repaying the director’s loan would be to declare non-cash dividends i.e. dividends which you do not take from the company (as you’ve already taken the money). But planning will be required to assess the company’s profits, and the timing needs to be carefully considered.

We’re regularly helping clients get the most out of their director loan accounts, so if you’d like to discuss yours then email us today to book a discovery call.

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