As a business owner or director of a company, taking out money from the business can be a confusing conundrum. Should I borrow money from my company by taking out a director’s loan account? Or should I loan money to my company? In fact, the vast majority of business owners and company directors we talk to aren’t even aware how to do this in the correct, legitimate way.
This is where a director’s loan account comes into play. A director’s loan account is a record of transactions between a company and its directors. It’s essentially money you take from your company’s accounts that cannot be classed as salary, dividends, or legitimate expenses. It is used to keep track of any money that a director borrows or lends to the company. The director’s loan account is an important financial tool for both the company and the director. However, if not used correctly, it can lead to nasty tax consequences and other legal issues.
We break down what a director’s loan account is, how it works, and the penalties that directors can face if they misuse it.
What is a Director’s Loan Account?
A director’s loan account is a record of transactions between a company and its directors. It is used to keep track of any money that a director borrows or lends to the company. In Lehman terms, it is money that you as a director borrow from your company, and will eventually have to repay. The account should be maintained separately from the company’s other accounts to ensure that there is no confusion between personal and company finances.
Another form of a director’s loan is when a director lends money to the company, for example to help with start-up costs or to see it through cash flow difficulties. As a consequence, the director becomes one of the company’s creditors.
How Does a Director’s Loan Account Work?
A director’s loan account works by recording any money that a director borrows from or lends to the company. For example, if a director borrows money from the company, the transaction is recorded as a debit in the account. If the director repays the loan, the transaction is recorded as a credit.
Similarly, if a director lends money to the company, the transaction is recorded as a credit in the account. If the company repays the loan, the transaction is recorded as a debit.
It is important to note that if the loan account is overdrawn (i.e., the director has borrowed more money than they have repaid), then the director will have to pay interest on the overdrawn amount.
Consequences for Misusing a Director’s Loan Account
Directors must ensure that they use their loan accounts correctly. If they misuse their accounts, they may face penalties from HM Revenue and Customs (HMRC).
The following are some of the penalties that directors may face for misusing their loan accounts:
S455 tax charges
If a director borrows money from the company which puts the directors loan account in an overdrawn position and does not repay it within nine months of the end of the company’s accounting period, they will have to pay a holding tax called section 455 tax. The tax is currently set at 33.75% of the amount of the loan and will need to be paid with the company’s corporation tax.
As this tax is a holding tax, it will be reclaimed from HMRC once the loan has been repaid. As the tax rate is so high it can cause cashflow problems for many businesses so avoiding being in this position is always an advantage.
Income tax charges
If a director’s loan account is overdrawn by £10k or more HMRC will consider this as a benefit in kind to the director and therefore will require a P11D to be completed.
Depending on what your personal income level is you will incur income tax on this benefit. This will be at a rate of either 20% ,40% or 45%.
To avoid the loan being considered a benefit in kind, the company must charge and receive interest on the overdrawn loan value.
If HMRC suspects that a director has misused their loan account, they may investigate the company’s finances. This can be a time-consuming and costly process, and can also damage the company’s reputation.
In conclusion, a director’s loan account is an important financial tool for both the company and the director. However, it must be used correctly to avoid penalties and other legal issues. Directors should ensure that they keep accurate records of their transactions and repay any loans within the required timeframes. If they are unsure about how to use their loan account correctly, they should seek professional advice.
We hope this has outlined to you what a director’s loan account is and how they are correctly used. If you’d like to know any further information on anything mentioned, or anything accounting related for that matter, please do not hesitate to get in contact with us at Nordens, where one of our trusted advisors would be happy talking you through your query.