While you, as the founder of your business, would be justified in thinking of the business and you as one and the same, the truth is that your business is a separate legal entity.
It is subject to different laws from you personally, and the money invested in the business is treated as the property of the business. You must be cautious concerning the granting of loans from the business to Directors, and if you are a Director, then this applies to you.
In other words, you cannot freely access your business funds for your personal use. You can, however, draw on company funds in the form of a director’s loan account. In this blog post, we offer a quick guide to what this entails.
What is a director's loan account?
A director’s loan account refers to taking out company money that is not salary, expense reimbursement or dividend.
It requires you to record all money taken out or repaid in a specific account, which will be listed as an asset or liability in the company’s end-of-year balance sheet depending on whether you owe the company money or whether the company owes you money.
You may need to take out a director's loan account if your personal finances take an unforeseen hit. As the name suggests, you need to be a company director to qualify for a loan like this.
Overdrawn director's loan accounts
A director’s loan account is overdrawn when you (as a company director) have taken company money that is neither dividend nor salary – in excess of the money you put into the company – and have not repaid it. You will have nine months to repay such a loan starting from the company’s year-end.
What is a close company, and why does it matter?
A close company is one that is run and controlled by five or fewer participants. A participant plays an active role in the company’s decision-making, such as a shareholder or director. In the context of a director’s loan account, the close company concept matters because of S455.
The S445 tax charge
According to Section 455 of the Corporation Tax Act 2010, if a director’s loan account is still overdrawn nine months after the end of the annual accounting period, the company has to pay 32.5% tax on either the outstanding amount at year-end or the amount nine months after year-end, whichever is lower.
This is a temporary tax amount, and the HMRC can repay the amount to the company nine months after the end of the accounting period during which the loan is repaid. The tax, however, will need to be paid even if the company is running losses, which can significantly strain its cash flow.
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Clearing an overdrawn director's loan account
If the director’s loan account is overdrawn and there is no cash to repay it, the company can clear the loan by voting a dividend that you, as the director, will subsequently not withdraw. Income tax will be payable on the dividend during the tax year when the dividend was voted.
It is important to remember that an unpaid director’s loan account is deemed a company asset. This means that if the company runs into financial trouble and is declared insolvent, a liquidator could still pursue the director’s loan account and demand that it be paid.
This could happen even if the company itself chooses to write off the loan – the liquidator can reverse it. We recommend, therefore, that you speak with an expert accountant like us about the different ways to write off an overdrawn director’s loan account.
Benefits in kind
A director’s loan is regarded as a benefit in kind if:
- The loan amount is equal to or greater than £10,000
- You are not paying interest on it
- The interest you are paying is less than HMRC's average official rates for beneficial loan arrangements
In either case, you will then have to report the loan by recording it on a P11D form as well as your self-assessment tax form. You will also have to pay taxes on the benefits.
Over to you
Directors should be aware that if too much money is borrowed and the company is unable to pay its creditors, the latter will be forced into liquidation. The liquidator can take legal action against the director to collect the debt.
