The Benefits Of The Director's Loan Account
What is it and how does it work?
POSTED BY MATTHEW BROWN ON 09/10/2017 @ 8:00AM
If you operate your business by way of a limited company, you may have heard us accountants referring to a director's loan account. So what is this hallowed director's loan account?
The director's loan account is a great way to extract money from a limited company!
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When a company starts out, it is not unusual for the director to introduce monies in order to pay for set up costs and the like. From the company's point of view, this money then becomes a liability as it is owed back to the director.
It is, as the name suggests, a loan from the director. As the company starts to generate a surplus of cash, this loan can be repaid to the director who lent it to the company.
A director of a company will usually pay themselves a salary. If the director also owns the business, they are likely to pay a minimal salary and then dividends on top since this is the most tax efficient way of extracting money from the company.
Depending on the rates of tax in a particular tax year, it may be more advantageous to declare additional dividends in excess of the amounts actually withdrawn in terms of cash. The tax due on these dividends would be declared on the director's personal tax return and the excess amounts not yet drawn would be shown in the director's loan account as amounts still due to be paid to the director. Again, the director can choose when to draw down on this loan, as and when the cash flow of the business allows.
"What happens if the director takes out excess money from the company and doesn't call it a salary or a dividend?"
Remember that you need to have sufficient profits after tax to be able to declare a dividend, so if a director takes out excess money from the company and doesn't call it a salary or a dividend, or even a company expense repayment, then it has to be treated as though the company has lent the director money. This is shown on the balance sheet as a debtor, i.e. the director owes the money back to the company.
Now, in many cases, it could be that the director is entitled to the money but maybe hasn't submitted an expense form or hasn't declared a dividend. Once that happens, the director's loan account clears back to zero.
"But what if it wasn't a dividend or expense and the director just fancied more money?"
There are two things to watch out for here. Firstly, if the director has an overdrawn director loan account at the end of the company year end and this director loan remains overdrawn (i.e. the director still owes the company money) 9 months after the year end, then HM Revenue & Customs will charge the company 32.5% tax on the amount outstanding.
Once the director pays it back (either physically with cash or by declaring a dividend) the 32.5% tax is repaid to the company from HMRC.
Secondly, the company should charge interest to the director on the loan at 2.5%. This is HMRC's official rate of interest. This is hardly ever going to happen since it will usually be the director's own company, so if it doesn't, the director has received a loan for no interest meaning it is a benefit in kind item which goes on the director's P11D.
The benefit in kind is reported on the director's personal tax return. The company also pays class 1A national insurance as it would on any other benefits it grants to its employees.
"This only applies to loans above £10,000!"
If you need any advice on the most tax efficient ways of extracting money from your limited company, as well the pitfalls and tax implications of directors loan accounts, then call us on 01908 774320 or click here to ping over an email and let's see how we can help you.
Until next time ...
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More about Matthew Brown ...
Matthew trained with Roger during the Hartwell & Co days and has followed Roger through his career to Essendon Accounts and Tax. Matthew prides himself on understanding clients and meeting their needs and has a great deal of experience with dealing with a variety of different businesses.
When not in the office, Matthew can sometimes be found on the golf course working on his swing or improving his cooking skills in the kitchen.
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