What is a director's loan account (DLA)?
Although it may be tempting for director/ shareholders to consider their company's money as personal funds to be plundered at will, in law a company is a seperate legal being from its owners or officers. The company's money belongs to the company, not the director/ shareholders, so there are always consequences (of one sort or another) when funds are moved between the two.
When a director lends money to a company, or vice-versa, the DLA is the place where those transactions are recorded.
Amounts due by the company to the director are recorded as creditors (liabilities); amounts due by the director to the company are recorded as debtors (assets).
What sort of "loans" are we talking about?
The "loans" that we are concerned with here are not necessary simple advances of cash; they make take many forms. For example:
- if a salary is payrolled but not taken, the unpaid amounts may be credited to the DLA;
- dividends may be voted but credited to the DLA (if the director also happens to be a shareholder), instead of being paid out;
- money due in respect of assets sold by the company to the director or vice-versa may be debited or credited to the DLA, if the amount due is not paid immediately but left outstanding;
- outstanding expense claims may be booked to the DLA;
- in most circumstances where the director takes more out of the company than is due for salary, dividends, or expense repayments, the difference is debited to the DLA;
- any interest charged on the loan but unpaid, would be booked to the DLA.
Also - crucially - when a company funds a director's private expenditure, the payment may be recorded as a loan (instead of a business expense) in order to avoid income tax and NIC charges on a "benefit in kind" that would otherwise be charged, had the company borne the expense.
What about transactions with family members or other associates?
If the company is a "close" company (one that is controlled by five or fewer shareholders, or any number of shareholders if those individuals are also directors), then any transactions with the director's family, friends, business partners or other associates also need to be recorded.
How do DLA transactions show up in my company's accounts?
Loans, advances and credits made by a company for the benefit of directors (and their associates) must be disclosed in the notes to the accounts. The disclosures must include the amount of the loan; the interest rate (if applicable); main conditions; and any amounts repaid or written off.
Loans by directors to the company, on the other hand, do not generally need to be disclosed, though in many circumstances it may help if they are.
The debtor (if money is owed to the company) or creditor (if money is owed to the director) will appear on the balance sheet.
Are directors' loans a "good thing"?
Small businesses are often funded with loans from directors, plus some share capital. The loans may be interest free or interest bearing; repayable on demand, or subject to formal repayment arrangements over a specified period. The company might also grant some form of security to the directors, though this is relatively uncommon among the smallest companies. Provided the loans are appropriately structured and the company is able to meet whatever repayment terms have been agreed, there's normally no issue.
If the loans are subject to a formal repayment arrangement, their presentation in the balance sheet should reflect whatever binding terms exist, so if the loans are repayable over a period of more than one year, the balance sheet should reflect an appropriate apportionment between short and longer term creditors; this may in turn influence key ratios like working capital and gearing.
If loans from the directors are interest bearing, the company will be obliged to withhold income tax at the basic rate when interest payments are made, accounting for the tax to HMRC on forms CT61. The interest will normally be tax deductible for the company. The recipients will need to declare the interest income on their Self Assessment returns, where credit will also be claimed for the tax that has been withheld by the company.
Things get a bit more interesting, however, when a DLA becomes overdrawn - i.e. when the director owes money to the company, not the other way around...
The tax consequences of overdrawn DLA's
If there were no tax consequences to running an overdrawn DLA, there would be a strong incentive for directors to simply borrow money from their companies, instead of taking salaries or dividends which attract income tax (and, in the former case, NIC as well). Of course, that's exactly why there are major tax consequences to running an overdrawn DLA.
Prior to the Companies Act 2006, overdrawn DLA's were generally prohibited (though in practice this was widely flouted). Nowadays, loans to directors are permitted although shareholder approval is required for loans in excess of £10,000. Where the director is also a controlling shareholder, approval is something of a formality.
Now, about those tax consequences...
Consequence 1: the 32.5% "section 455" charge
Companies are liable under section 455 of the Corporation Tax Act 2010 to pay a 32.5% tax charge on loans to directors (and certain other individuals) that are not repaid on a permanent basis within nine months of the end of the company's accounting period. The charge used to be 25%, but it went up when the the dividend tax rates went up. If it hadn't, everyone would be busy running overdrawn DLA's instead of taking dividends....
The tax may be recovered from HMRC in future if the loans are subsequently repaid to the company; but recovery can only take place nine months after the end of the accounting period in which the loans are repaid. Therefore there is a significant time lag between the loan being repaid, and the tax being recovered.
The section 455 charge does not apply in a few limited circumstances, for example where the amount borrowed by the director of a close company does not exceed £15,000, the individual works full time in the business and they do not have a "material interest" in the company. There is no "material interest" where the individual, together with their associates, does not control more than 5% of the ordinary share capital.
Consequence 2: taxable benefits
If loans to a director exceed £10,000, a taxable benefit arises unless the director is charged interest at or above the Official Rate. The director will be liable to pay income tax on the "cash equivalent" of the benefit, calculated using the average or daily method. The company will be liable to pay Class 1A NIC on the benefit.
The benefit arising from low rate or interest-free loans needs to be reported by the company on form P11D on an annual basis.
Methods of repaying an overdrawn DLA
An overdrawn DLA may be repaid in different ways. When the director has insufficient funds (or simply does not wish) to repay the loan in cash, the most common repayment method is to vote a dividend which is credited to the account (rather than being paid out). Where there are insufficient distributable profits, then a bonus could be payrolled instead.
Should I repay my overdrawn DLA?
Generally it is preferable to repay an overdrawn DLA within nine months of the end of the accounting period in which it becomes overdrawn, for two principle reasons. First of all, due to the cost of the section 455 charge and (where there is a taxable benefit) the income tax and NIC charges, it is generally more tax-effective to repay the loan, for example by way of dividends, rather than leaving it outstanding.
Secondly, if the company subsequently enters insolvent liquidation, the director may then be forced by the liquidator to repay the loan in order that the company can repay its creditors. The director's personal assets may be at risk if they are unable to repay the company at that point.
What about writing off an overdrawn DLA?
A close company can write off a director's loan but again there will be significant tax consequences. The loan must be formally waived however, otherwise the liability technically remains.
For the individual, the amount written off may be charged to income tax as a deemed dividend. Class 1 NIC may also be payable by the company and the individual, if the write-off amounts to "an emolument from an office or employment". Therefore writing off an overdrawn DLA may be an expensive option and repayment will therefore be the preferred option in a majority of cases.
From the company's perspective, the write-off will not be deductible against profits for corporation tax purposes.
If the company is insolvent, the DLA should never be written off without first seeking legal advice.
If a DLA is overdrawn and the company is liquidated, the liquidator will seek to recover the debt for the benefit of creditors. Legal action may be taken against the directors, potentially leading to bankruptcy in extreme cases.
Where the DLA is overdrawn, the tax consequences may be severe and therefore good record keeping and careful planning are essential.
If too much money is borrowed and the company is unable to repay its creditors, liquidation may be the outcome and the liquidator would be in a position to take legal action against the directors to recover the debt.