A Director’s Loan Account (DLA) can be a useful tool for managing finances in a small business. However, it can also arise unintentionally and lead to unexpected tax implications if not handled correctly. In this blog we will explain what a Director’s Loan Account is, how it can be used, and the potential tax consequences, including s455 Corporation Tax and P11D benefits. 

 What is a Director’s Loan Account? 

A Director’s Loan Account is an account on a company’s balance sheet that records transactions between the company and its directors, other than salary, dividends, or expenses. This account can show money the director has borrowed from the company or money the director has lent to the company. 

 How Can a Director’s Loan Account Be Useful? 

Assuming the company is not in financial difficulties and the shareholders have approved the loan a Director’s Loan Account can be advantageous in several ways: – 

• Flexible Cash Flow Management: Directors can temporarily borrow money from the company to cover personal expenses, avoiding the need for external financing. 
• Directors can lend money to the company to help manage cash flow during difficult periods.
• Short-term Financial Support: Directors can use the account to fund short-term needs without the formalities of applying for a bank loan. This can be especially helpful for small businesses that may not have easy access to credit. 
• Efficient Tax Planning: Properly managed, a Director’s Loan Account can be part of a tax-efficient remuneration strategy, balancing salary, dividends, and loans to optimize tax liabilities. 

 How Can a Director’s Loan Account Arise Unexpectedly? 

But despite its potential benefits, a Director’s Loan Account can sometimes arise unintentionally and often with unexpected tax bills and the inability to repay the loan. 

  Here are the two most common scenarios: 

• Personal Expenses Paid by the Company:If directors use company funds for personal expenses (e.g., personal travel, entertainment), these amounts are recorded in the DLA.Such transactions can accumulate over time, leading to a significant loan balance.
• Dividends in Excess of Profits: Paying dividends without sufficient profits can lead to a loan account if the company later determines it can’t distribute those profits. Ensuring profits are accurately calculated before declaring dividends is essential. 

 Tax Implications of a Director’s Loan Account 

1. s455 Corporation Tax

If a director borrows money from their company and doesn’t repay it within nine months and one day after the company’s accounting period ends, the company must pay s455 Corporation Tax on the outstanding loan amount. 

The s455 tax rate is currently 33.75%, matching the higher dividend tax rate. 

So, if you have an outstanding loan of £10,000, that’s an additional £3,375 Corporation tax to pay. 

When the loan is repaid, the company can reclaim the s455 tax, but there’s typically a delay of at least nine months before the refund is processed. 

In order to avoid the s455 Tax, ensure loans are repaid within the specified time frame and avoid recurring withdrawals that reset the loan period, known as  ‘Bed and breakfasting. 

2. P11D Benefits

Loans to directors and employees can also have implications for P11D benefits if the loan amount exceeds £10,000 at any point during a tax year. 

Where the loan is more than £10,000 it is considered a benefit in kind and must be reported on form P11D. 

 The taxable benefit is based on the official rate of interest set by HMRC. If the company charges no interest or less than the official rate, the difference is taxable as a benefit. 

In addition to the director incurring a personal tax charge on the benefit in kind, the company must pay Class 1A National Insurance on the benefit. 

We see so many small business owners, accidentally incurring overdrawn directors loan accounts that go on to cause both personal and company cashflow issues. This can be easily avoided by understanding your numbers and ensuring that any monies taken are available.  

Best Practices for Managing a Director’s Loan Account 

To avoid unexpected tax liabilities, follow these best practices: 

• Keep Accurate Records: Maintain detailed records of all transactions involving the Director’s Loan Account. 

• Regularly review and reconcile the account to ensure accuracy. 

• Repay Loans Promptly: Aim to repay any borrowed funds within the nine-month window to avoid.  

• Charge Appropriate Interest: If loans exceed £10,000, consider charging interest at or above the HMRC official rate to avoid P11D implications. 

• Document the terms of any loan agreements clearly. 

• Monitor Dividends and Profits: Ensure dividends are only paid out of distributable profits to avoid inadvertently creating a loan situation. 

• Regularly review the company’s financial position before declaring dividends. 

• Seek expert advice from your accountant throughout the year. 

 A good accountant will work with you over the course of your financial year to monitor the balance on your DLA, so unexpected tax bills shouldn’t happen.