Directors Loan Account – What is it and what are the tax implications?

Often, people who run Limited Companies, particularly those that have only recently set the company up have either never heard of a Director’s Loan account or those that have heard of them do not know how they operate from a tax perspective.

First of all, something that is often overlooked but should be understood from the get-go is that when you set up a Limited Company it becomes a separate legal entity and from that point on any money in the Limited Company bank account belongs to the Company!

So how can you withdraw money from the Company?

As a Director of the company, you can make withdrawals using a Director’s Loan.

What are Director’s Loan Accounts (DLAs)?

The Director’s loan is a virtual account that summarises the transactions between you and the company. HMRC defines a Director’s loan as money taken from your company that isn’t either:

• A salary or dividend
• Money you’ve previously paid into or loaned the company

There will also be occasions when you pay for a business expense using your own personal bank account – in this case, you can pay yourself back using the Limited Company bank account.

If you make any other withdrawals from the company bank account, either via cash withdrawals or by making personal purchases, then these must be recorded in your Directors Loan Account.

These are then reviewed at the end of the company’s financial year and the DLA will then either be in a credit or a debit position – if in credit then the company effectively owes you money and you won’t have to pay any tax but if we look at the reverse position and the DLA has a debit balance, then this means your DLA is overdrawn and you owe the company money – it’s at this point that you will then need to consider the tax implications of an overdrawn DLA.

Tax implications of an overdrawn Director’s Loan account

An overdrawn director’s loan account is effectively an interest-free loan – which might sound attractive, but an overdrawn DLA can have tax implications on both the company and the Director.

From the company’s perspective – if the DLA is still overdrawn nine months after the company year-end, a tax charge called S455 is applied. The S455 tax charge is calculated as 32.5% / 33.75% (the rate of 33.5% applies on any outstanding loan balance from April 2022) of whatever balance was outstanding on the DLA at the period end. The S455 tax is payable nine months and one day from the end of the company’s accounting period.

The overdrawn amount must also be shown on the company’s Corporation Tax Return.

If you pay back the entire director’s loan within nine months and one day of the company’s year-end, you won’t owe any tax.

Another tax implication to be aware of is that if the DLA is overdrawn by more than £10,000 then it will trigger what is called a benefit in kind as you are getting a loan without paying any interest. The benefit in kind will need to be reported on a P11D form at the end of the tax year and must be declared on your personal tax return and pay income tax equal to HMRC’s notional interest rate which currently sits at 2%.

The benefit in kind will also be liable to company tax. For the 22/23 tax year, the company will need to pay Class 1A National insurance at the rate of 15.05% on the full amount.

What happens if the Director is not able to repay the loan within nine months of the year-end? In this case, the company may elect to write off the loan however the tax responsibility then falls on the Director, who must pay tax on the loan as though it were dividend income through their own personal tax return (self-assessment).

As with all taxes in general, the Director’s loan account is a complex area and has many different rules attached to it and as a Director of a Limited Company, whether newly appointed or if you have been in the position for several years it is always good to understand how these accounts work. Don’t forget the company is a separate legal entity – if you lend the company money then you can take it back if there are enough funds available but if you borrow money then make sure you don’t borrow more than can be cleared with dividends otherwise you could end up paying extra tax.

Steven Kivelehan,
Senior Accountant at TOAST