Director’s Loan: What Is It and How Does It Work?

One of the basics of ensuring a company's health is separating a business' funds from its leaders' cash flow. Company start-up services will tell you as much; when a director borrows money from his company, he will have to repay it. The reverse is true; the company needs to repay a loan from the director, for example, even if he lent the money for start-up costs. Here are other things to know about directors' loans.

What is the director's loan account?

The DLA or director's loan account records the money you borrow or lend to your money. Keep an eye on the balance; shareholders and other creditors might be concerned about your small business' health when you overdraw. Come up with a good DLA when you hire accountancy services for limited companies.

Your company should decide on the interest rate for a director's loan. If the interest is below the official rate, though, the HMRC could consider this discount as a 'benefit in kind.' It means it could tax the director for the difference between the interest rates.

Is there a limit to the loan amount?

Technically there is no legal limit to the amount you can borrow from a company. However, you should think about whether the company can afford a loan, and whether the lack of it will affect operations. Note as well that loans at or above £10,000 need approval from all shareholders and are automatically classed as a 'benefit in kind,' to be included in the debtor's self-assessment tax return.

How long is the repayment period?

You must repay this type of loan within nine months and a day from the company's year-end. Otherwise, unpaid balance would be subject to an S455 tax, which is at 32.5 per cent. It is possible but tedious to claim back this penalty.

You could put off paying the company's corporation tax until you can repay the director's loan; since the tax payment deadline is nine months after the end of your company's financial year, you have enough time.

Note as well that you need to wait at least 30 days between repaying and taking out a loan. Some directors avoid tax penalties by waiting up until the deadline to pay and then taking out a new one. HMRC considers this tax avoidance; avoid getting tagged as avoiding taxes by not relying on director's loans for cash infusions. Manage your finances by hiring an accountant for your personal tax affairs.

What does it mean to take out a loan 'by accident?'

Directors might inadvertently take out a director's loan when they pay themselves illegal dividends. A company can only pay dividends out of profits; if the business has not yet become profitable, you cannot pay yourself in this way. Avoid doing this by having a clear record of your company's cash flow.

How do you become a creditor to the company?

You should consider as income any interest you gain from a loan to your company; it needs to be on your self-assessment tax return. It is a business expense for the company, and there needs to be a deduction of at least 20 per cent at the source.

Conclusion

When you take out a director's loan, you get more access to money for short-term or one-off expenses. Don't treat this as a line of credit, though; director's loans are admin-heavy and could cause you to incur significant tax penalties. They are a good source of emergency funds, but you cannot rely on them for your monthly needs.

Ensure your business' financial health when you consult 1 to 1 Accountant. We are a Hillingdon firm offering accounting services for small businesses—whether you need assistance with payroll concerns, company formation, year-end accounts, or more, we have you covered. Contact us today for an online consultation or other enquiries.