Directors’ Loan Accounts

It is very common for directors to lend money to, or borrow funds from, their companies.  As many directors are shareholders in the companies they operate it is easy for them to assume that funds can be taken out of “their” company without keeping appropriate records or properly considering the tax implications.  It is important to remember that companies are separate legal entities. Any transactions between a director/shareholder and their companies will have varying implications and tax treatments and therefore need to be carefully recorded, which is often dealt with via a director’s loan account.

Director’s Loan Accounts and How They Work

A director’s loan account is operated like a current account with a clearing bank showing the running balance between the director and the company.  The account will show various credits (i.e. monies owed to the director from the company) such as undrawn salary, undrawn dividends, money put into the business and expenses paid on behalf of the business (not reimbursed in cash) etc.  Monies withdrawn by directors from the business for non business purposes will be shown as a debit to the account and reduce the running balance.

When the balance is, in overall terms, a credit figure, then this is classed as a loan to the company from the director.  When in net terms the director has borrowed funds from the company there will be a debit or overdrawn balance. 

If the company has more than one director then strictly speaking separate records for each should be kept.

One particular point to note is that otherwise unpaid remuneration or dividends can only be credited to a director’s loan account at the point at which such remuneration (received in an individual’s capacity as a director) or dividends (received in an individual’s capacity as a shareholder) is formally voted. 

Credit Balances

Where in net terms a director has introduced funds to a company such that the company owes money to that director then generally the consequences are fairly straightforward.  Interest may be charged by the director to the company. Any interest payments made must be subject to a 20% tax deduction at source with any higher rate liability collected via the director’s self assessment tax return.  Interest paid to directors, whilst taxable, can be a useful form of profit extraction as no liability to National Insurance arises. 

Debit/Overdrawn Balances

Loans to directors/overdrawn balances where in net terms the director/shareholder has withdrawn more funds than to which he/she  is entitled results in a debit or overdrawn balance.  Strictly speaking any such arrangement (where the overdrawn balance is £10,000 or more) should be formally approved by the shareholders in the company to comply with the requirements of the Companies Act 2006 and overdrawn balances (at whatever level) must be disclosed in the company’s annual accounts.  Furthermore, if there is an overdrawn balance then the director/shareholder has an obligation to repay the balance at some point.

Overdrawn director’s loans can also give rise to tax charges under Section 175 ITEPA 2003 relative to the benefit-in-kind of having a cheap or interest free loan.  Small loans (i.e. those of £5,000 or less) are ignored for this purpose but (almost) all other loans must be disclosed and a benefit-in-kind calculated thereon and declared on form P11D.  Failure to declare this benefit on form P11D is a common error and if identified via a PAYE audit or review of the company’s corporation tax return could well be the starting point for a wider investigation of the affairs of the company and its directors/shareholders. 

As well as producing a personal income tax liability for the director the P11D entry produces a liability to Class 1A National Insurance for the company. 

Conclusion
Director’s loan accounts can be a simple way for both companies and directors to obtain funding without the need to involve a third party.  However, it is important to understand the consequences and effects of any transactions undertaken on both the company and the director/shareholder.