A guide for small business owners and limited company directors
If you run your own limited company, you will almost certainly have a directors' loan account, even if you have never heard it called that. Understanding what it is, how it works, and its tax implications can save you a significant amount of money and keep you on the right side of HMRC.
What Is a Director's Loan Account?
A directors' loan account (DLA) is a record of all the money that passes between you as a director and your company outside of salary, dividends and expenses.
Any time you take money out of the company that is not a salary or dividend, it is recorded as a loan from the company to you. Equally, if you put money into the company from your own pocket, that is recorded as a loan from you to the company. The DLA is simply the running balance of those transactions.
Most directors of small limited companies have a DLA without realising it. The problems tend to arise when the account goes into the wrong territory, and nobody notices until the accounts are being prepared.
When Is a DLA Overdrawn?
Your DLA is overdrawn when you have taken out more from the company than you have put in. In other words, you owe money to your company.
This can happen easily. Common examples include taking cash from the business before your dividend has been formally declared, paying personal expenses through the company account, or drawing down more than the company has in distributable reserves.
An overdrawn DLA is not automatically a problem, but it does have tax consequences that directors often do not expect.
What Are the Tax Implications?
The Section 455 charge
If your DLA is overdrawn at your company's year-end and has not been repaid within nine months and one day of that date, HMRC charges your company a Section 455 tax at 35.75% of the outstanding balance.
This is a temporary charge, as it is repayable to the company once you repay the loan. However, the repayment process takes time, and the cash flow impact in the meantime can be significant. Many directors are caught by this charge simply because they were not aware that the clock was running.
Benefit in kind
If your DLA is overdrawn by more than £10,000 at any point during the tax year and the loan is interest-free, HMRC treats the benefit of that loan as a benefit in kind. This means it needs to be reported on a P11D, and both you and the company may face additional tax and National Insurance Contributions as a result.
Charging interest on the loan at HMRC's official rate removes this liability, but the interest received by the company then becomes taxable income.
What If the Company Owes You Money?
A DLA can also run in your favour. If you have lent money to your company or paid business expenses personally, the company owes you that money back. You can repay yourself at any time without tax consequences, and no interest is charged.
This is worth keeping track of, particularly in the early stages of a business when directors often put in their own funds to get things off the ground.
What Happens If an Overdrawn DLA Is Written Off?
If the company writes off a director's overdrawn loan rather than requiring repayment, HMRC treats the amount written off as employment income. That means it becomes subject to Income Tax and National Insurance Contributions in the year it is written off, which is rarely a tax-efficient outcome.
Writing off a DLA is something to approach carefully and only with proper advice.
How to Keep Your DLA in Good Order
The most common issue with directors' loan accounts is not fraud or deliberate avoidance. It is simply a lack of visibility. When you run a small business, the line between company and personal money can feel blurry, particularly if you are the sole director and shareholder.
A few straightforward habits make a significant difference. Keeping business and personal spending clearly separated, ensuring dividends are properly declared before being drawn, and reviewing your DLA position regularly with your accountant all help to avoid unexpected tax bills at year's end.
If your DLA is heading towards being overdrawn, there are options. Voting a dividend, taking additional salary, or repaying the balance before the nine-month deadline can all prevent the Section 455 charge from arising.
Be Advised…
Whilst currently in consultation, HMRC is planning draconian reporting requirements on directors’ loan accounts and participator loans to connected companies. The move is designed to target the enormous £ 14.7 billion small business tax gap, which represents 40% of small business corporation tax liability.
The proposals to clamp down on potential abuse of close company loans to participants will affect owner-managed businesses and small companies, although HMRC has not yet put a figure on the number likely to be affected by the rule change. Likewise, there is no timetable for the changes, although they are likely to be introduced quickly, as they are part of the Government’s wider anti-tax-avoidance strategy.
Speak to a Local Accountant
Directors' loan accounts are one of the areas where small issues can escalate quickly if they go unnoticed. At PG Owen, we help directors across Bath, Warminster and Midsomer Norton stay on top of their position throughout the year, not just at the time accounts are filed.
If you have questions about your own DLA or want to make sure your company records are in good shape, we are happy to help. Your first consultation is free of charge and without obligation. Get in touch today.