If you have recently formed a limited company, the director’s loan account can be a tough concept to get your head around. But we promise it’s actually quite easy to understand.
What is the Director’s Loan account?
The director’s loan account is a virtual account that exists to record money put in and taken out by you the Director. That computer your bought on your personal credit card or that lump sum of cash you lent to your Company during the startup stage may be things you want to get the money back for either now or in the future when the Company is in the right position to repay you.
If you put £5,000 say, in your Company bank account you will appear as a creditor in your books – i.e you will appear in your books as being owed £5,000.
Equally don’t get carried away, if you take out more money that you put in you will be a debtor – someone who owed money back to the Company. Don’t get carried away there are legal consequences to this which we talk about later.
In effect a Directors Loan is a record of the financial relationship, that you, a director has with the company in your accounts.
What items could be considered Directors Loan to the Company?
- The money you have invested (seed capital or money loaned to ease a tricky cash situation)
- Things you have bought on behalf of the company (like a computer or stationary)
- Travel expenses (but watch out for any personal tax implications here)
- The net amount (after tax) salary that you should have been paid if you chose not to take it due to tight cash
- Dividends allocated to you at the end of a previous financial but not yet drawn
- Interest charged on a loan (but be careful of personal tax implications in doing this)
Once you feel your Company has sufficient funds to repay you, you are free to repay yourself just like any other creditor. There are no tax or dividend implications so it is really important to log these transactions as you go along.
What items should be shown on the Director’s Loan Account as a repayment or payment to the Director?
- Amounts that the company has paid you (monthly drawings)
- Personal Tax payments
- Personal expenses made on the Company credit card if you have one
Things to watch out for?
An Overdrawn Loan Account is a major thing every Director needs to watch out for. You may have heard this phrase used before – it is basically whereby the Director draws out more than he/she is owed within a financial year. It isn’t the end of the world, you are able to repay or offset the overdrawn amount within 9 months of the end of your year end. However the problems with our frenemy starts to arise if you are unable to do so. Without going into too much detail, here is a summary of the main implications:
The Company needs to disclose on their Tax Return (CT600) something called a S455 charge. This is a tax charge which is currently 25% of the overdrawn balance. The good news here is that the Company can claim this charge back again once the loan account is repaid.
If the loan was repaid within 9 months of the year end the Company won’t have to pay the S455 charge, but will still need to disclose it on the Tax Return.
Benefit in Kind
HMRC consider the overdrawn loan account balance as a tax free loan. So a benefit in kind charge arises at HMRC’s rate of interest that should have been charged on the loan. Fortunately this applies only if the loan was more than £10,000 for tax year 2016/2017 but it will affect both the Company and the Directors Personal tax return (as well as potentially having some knock on effect for payroll tax coding).
Don’t let the implications of an overdrawn loan account scare you it’s just really important to keep good records.
As the Director of a small business you will want to do all you can to ensure your Company has the greatest chance of success. Investing your own money is one of the most common ways to help your business along. Whilst logging it as a Directors loan may not feel important at such a critical time, once your business begins to succeed you will be able to repay yourself without any tax implications because it is a simple loan.
Don’t forget you already paid tax on earning this money your loaned once before, so dont forget to log it in your Directors loan, otherwise you may end up paying tax twice on the same money you return to yourself when you want to put it back in your personal savings account.