7.1. What is a director s loan account?

7. Directors loan accounts 7.1. What is a director s loan account? A director s loan account (DLA) (also known as a director s current account) is a notional balance between a company and its directors. It s not a bank account and is not represented by real monies. It records: monies drawn by the director, on account of salary, dividends, expenses, etc. (if not directly attributed to salary/dividend at the time of drawing) other drawings by the director - e.g. personal bills paid by the company net amounts of salary and dividend due and not physically paid to the director expense re-imbursements due - e.g. company bills paid personally by the director. Download Zone For a Sample DLA, visit http://books.indicator.co.uk. You ll find the access code on page 2 of this book. Normally a DLA must be kept in credit, i.e. the opening balance, plus net salary and dividends voted during the year, plus expense reimbursements must be more than the amounts you draw out. In practice, this balance is normally achieved by adjusting the amount of the year-end dividend that you receive. When your DLA is in credit, it s a credit balance on the accounts and shows as a creditor, i.e. an amount owed by the company to you. 7.1.1. Why should I use a director s loan account? You may want to draw money from the company on an irregular basis and may therefore operate a loan account with it. The account is credited when a bonus or dividend is voted to you and you then draw from the account as and when necessary. You are voted a bonus annually once the accounts have been finalised. Rather than being paid, this bonus is credited to the DLA. During the year, you then draw the money as and when you need it, reducing the balance on the account. 83

As long as the account is in credit and an amount is drawn against that credit, there s no tax or NI to pay as the sum originally credited to the account has already suffered tax and NI before being credited. You may also arrange for personal bills to be settled from the loan or current account. Again, provided the account is in credit, no tax or NI liability arises at the time the bill is settled. 7.1.2. Can I charge the company interest on credit balances? Yes. While the company owes a director money, the director is entitled to charge interest at a reasonable commercial rate. 7.2. What does it mean if the account is overdrawn? A DLA will become overdrawn if you take out more than you re entitled to. In such cases, the balance is a debtor in the company accounts, i.e. an amount owed to the company by you. A DLA can become overdrawn for a number of reasons. You may need to withdraw money to meet day-to-day living expenses before the bonus or dividends have been voted or credited to the account. Or if there is insufficient profit to declare a dividend to cover your drawings during the year then the DLA will remain overdrawn at the year-end. Another reason is that you may have inadvertently used the company credit card for personal expenditure. It s also not uncommon for directors to take a loan from their company. They see it as an easy way to extract interest-free cash. These loans will also be posted to the DLA as money owed by you and therefore could lead to an overdrawn loan account. 7.2.1. What s wrong with an overdrawn loan account? An overdrawn loan account has a number of problems: (1) It must comply with the Companies Act Under s.197 of the Companies Act 2006, the general rule is that a company may not make a loan to a director of the company (unless the loan is less than 10,000 (s.207(1))). 84 The Company Director s Manual,

If it s over this amount, the shareholders have to agree to it first. This would require an ordinary resolution to be passed by them. To do this properly, the company must provide the shareholders with the full details of the loan so that they can make an informed decision. (2) It s subject to a 25% Corporation Tax charge A DLA might sound like an easy way to extract interest-free cash from your company - so it s no surprise that HMRC will want its slice. Suppose you take a loan - or a number of loans - from the company. If you don t repay either all or part of that sum by the end of the company s financial year, then the outstanding overdrawn balance - however much has not been repaid - will be liable to a tax charge. This liability is subject to the loan not being repaid within nine months of the end of the financial year. If the company is a close company (i.e. one that has five or fewer shareholders), then under s.455 of the Corporation Tax Act 2010, the company will be charged tax at 25% of whatever amount remains outstanding. It doesn t matter if the business made a loss that year - this particular tax bill will still have to be met. But if the loan is repaid within nine months of the end of the company s financial year, then no tax will be charged. When the loan is finally cleared, the company can reclaim any tax that was charged on it. In those cases where the director repays some of the loan, then the company is entitled to reclaim the tax on the proportion of the loan that has been repaid. The company makes a loan of 10,000 to you on January 1 2012, which is reported on the company s CT return for the year-ended December 31 2012. The company pays a s.455 charge of 2,500 ( 10,000 x 25%) on October 1 2013 as the loan is still outstanding on that date (nine months after the year- end). The loan is repaid in full to the company on November 30 2013 and this is reported in the company s return for the year-ended December 31 2013. HMRC repays the s.455 charge by offsetting the 2,500 against the CT due for payment on October 1 2014. Section 455 is an unusual tax liability insofar as it s temporary and the amount is repaid when the DLA is cleared - think of it as a security deposit to HMRC, guaranteeing that the overdrawn balance will be corrected. No t e. Any size of loan can trigger a s.455 charge (even if the loan account is overdrawn by less than 10,000 (see below)). 85

(3) It s a P11D benefit-in-kind You might also have to pay tax on an overdrawn DLA. If the loan account is overdrawn by more than 5,000 ( 10,000 from April 6 2014) then, depending on your other income, you could be liable to income tax on the overdrawn amount. This is because as soon as the DLA is overdrawn by more than 5,000 ( 10,000 from April 6 2014), the loan will be treated automatically as a P11D benefit in kind and you will have to pay tax on the cash-equivalent value of the benefit of the loan. Since it s a benefit, the employer - that is the company - will also have to pay 13.8% Class 1A NI on it. The loan will be regarded as a benefit in kind the moment the account is overdrawn in excess of 5,000 ( 10,000). Even if the subsequent repayments return the amount below 5,000 ( 10,000), you are still liable for the period - be it a day or a month or a whole year - during which the loan stood above 5,000 ( 10,000). The cash-equivalent is the interest that would have been payable if you had paid interest at the official rate (less any actual interest paid by you). The official rates of interest can be found at http://www.hmrc.gov.uk/rates/interest-beneficial.htm. If you had borrowed 10,000 from your company on April 6 2013 and then repaid the full amount by April 5 2014, with an official interest rate of 4%, the taxable benefit would be 400 ( 10,000 x 4%). As a higher rate taxpayer, the director will pay 160 ( 400 x 40%) or 200 ( 400 x 50%) tax and the company will pay 55 ( 400 x 13.8%) NI. There are two ways of calculating the cash-equivalent value, the averaging method and the exact daily method. The two methods will produce the same result if the level of the loan does not vary during the tax year. However, in the real world, a director will often repay a loan gradually or increase their borrowing during the year. You borrow 8,000 on April 6 2013 and repay 3,000 on February 5 2014 leaving a balance of 5,000 still outstanding on April 5 2014. The cash equivalent value of the benefit calculated using the two methods is: Averaging method Average balance ( 8,000 + 5,000)/2 6,500 Taxable benefit 6,500 x 4% 260 Exact daily method 306 days to February 5 2014 8,000 x 4% x 306/365 268 59 days to April 5 2014 5,000 x 4% x 59/365 32 Taxable benefit 300 86 The Company Director s Manual,

The averaging method - (balance at start of year + balance at end of year /2) - it s much easier to work out on variable loan balances and where the loan balance was much higher earlier in the tax year than at the end, the exact method will produce a much higher cash-equivalent figure (therefore more tax to pay) than the averaging method. To summarise, it s important to keep the balance of your director s loan account below 5,000 ( 10,000 from April 6 2014) at all times to avoid being taxed on the benefit in kind. And the rule of thumb is to repay any company loan, whatever its size, within nine months of the year-end to avoid the 25% tax on the overdrawn amount. 7.2.2. How will HMRC find out that the loan account is overdrawn? Even if you are the only shareholder and director of the company, the annual accounts must show the value of loans outstanding to the directors and their immediate families and the maximum balance during the year. This disclosure is required to inform the other people and organisations who are owed money by the company, how their cash is being used. If a bank manager can see the funds he lent to the company have been provided to the directors for their own private purposes, he may not be very happy! The bank may have the power under its loan agreement to demand an immediate repayment, possibly from the directors personally. 7.3. What s the best way to clear an overdrawn loan account? As mentioned in 7.1., the classic solution to clear any director s overdrawn loan account is to take extra remuneration from the company in the form of dividends. This is preferable to voting a bonus to clear the account because there s no NI to pay on dividends: Bonus To clear a 6,000 loan with a bonus would mean a gross salary of 10,000 for a 40% taxpayer. The tax cost of which would be 4,000 in income tax and 1,380 ( 10,000 x 13.8%) in employers NI. Dividend You would need a 6,000 dividend to clear a 6,000 loan. The income tax cost would be 1,500 ( 6,000 x 25%) and there would be no employers NI to pay. So in most cases the most tax-efficient way of clearing a loan account is to take a dividend. 87