If you’re a director of a UK company, chances are you’ve heard about a Director’s Loan Account (DLA), but you might not realise how common and consequential this tool can be. According to recent sources, around 25 % of small business directors in the UK have used a director’s loan at some point to support cash‑flow.
The tax rules aren’t trivial: for instance, if a loan remains unpaid nine months after the company’s year‑end it triggers a corporation tax charge of 32.5 % under Section 455 of the HM Revenue & Customs (HMRC) regime. Using a DLA offers flexibility, but that flexibility comes with responsibilities and risks.
Whether you’re borrowing from your company or lending to it, the rules around DLAs are strict, and getting it wrong can lead to hefty fines and complications. Let’s break it down in simple, clear terms.
What is a director’s loan account (DLA)?
A Director’s Loan Account is essentially a record of financial transactions between a director and the company. It tracks money that a director either borrows from the company or lends to the company. These loans are separate from the director’s salary, dividends, and regular business expenses.
There are two key components:
- Money owed to the director: If the company owes the director money (for example, if the director has lent money to the company), it’s recorded as a liability (creditor) in the company’s accounts.
- Money owed by the director: If the director borrows from the company, the amount is recorded as an asset (debtor) in the company’s books.
This system helps maintain clarity in the company’s financial records by isolating the director’s personal financial dealings from business operations.
How does a director’s loan happen?
A Director’s Loan arises when you take money from your company for personal use (rather than for legitimate business expenses) or lend money to the company. If you, for example, borrow £5,000 from the company to cover a personal cost, that would be a Director’s Loan.
Importantly, loans are expected to be repaid. Any money taken out that’s not part of your salary or dividends (which are taxable differently) must be treated as a loan, and the company must track it carefully.
Is there a process for borrowing or lending money?
Yes, and it’s critical to follow the correct procedure. If the loan is more than £10,000, shareholder approval is required. Even if you’re the controlling shareholder (which is common), getting formal approval ensures the loan complies with legal and company rules. For smaller loans, while the approval process might be less formal, it’s still good practice to document everything properly to avoid confusion later.
The ‘benefit in kind’ tax on an overdrawn DLA
One important thing to note is if you borrow more than £10,000 from the company, the taxman sees this as a benefit in kind. Essentially, because you’re receiving the money at a potentially better rate than you would from a bank, the difference between what you pay and the standard HMRC rate is considered taxable income.
So, if the company gives you a loan at a rate lower than the official HMRC rate, you will likely owe taxes on the benefit, calculated based on the interest difference. The key takeaway here is that if you’re borrowing large sums from your company, make sure the loan terms are compliant with tax rules.
Tax charges: What happens if the loan stays unpaid?
Here’s where things can get tricky. If your loan remains unpaid for more than nine months after the company’s year-end, the company faces a tax penalty. Known as the Section 455 tax charge, this is a 32.5% tax on the outstanding balance of your loan.
The good news? Once you repay the loan, the company can reclaim this tax charge, but it’s a lengthy process. Ideally, you want to avoid this situation by paying off the loan on time, as the tax burden can add up quickly.
What if the loan was not approved correctly?
It’s crucial to ensure that the correct procedures are followed when taking out a director’s loan, especially if the amount exceeds £10,000. Failing to get proper shareholder approval could make the loan voidable under the Companies Act 2006, potentially leading to legal complications.
Moreover, any unapproved loans could be treated as improper and might lead to personal liability for the director, which no one wants to face. So, always get approval and ensure everything is well-documented to avoid issues down the line.
Can dividends turn into director’s loans?
You might be surprised to learn that dividends, if improperly paid, can be treated as director’s loans. This can happen if the company doesn’t have enough distributable reserves (i.e., profits) to cover the dividend payments.
If you receive a dividend when the company doesn’t have enough profits, it becomes an illegal dividend, which is then treated as a director’s loan. If this happens, the loan must be repaid within nine months to avoid penalties, so it’s crucial to keep an eye on the company’s profits before paying out dividends.
Lending money to your company
Now, on the flip side, you might also consider lending money to your company. This can be a practical option if the company needs funding, and you’re in a position to help. But, as with borrowing, there are rules to follow.
If you lend money to your company, you can charge interest. This interest must be declared as income on your tax return, and the company can deduct it as a business expense. However, don’t forget that you’ll need to comply with tax rules and charge interest at the correct rate.
What happens if the company faces financial problems?
If the company goes into liquidation, things can become much more complicated. An overdrawn DLA means that you, as the director, owe money to the company. If the company is unable to pay back the loan, the liquidator can come after you personally to recover the debt.
In such cases, the liquidator will attempt to recover all outstanding loans, and you might even face personal liability if the company was unable to support the loan when it was taken out. Additionally, directors who have overdrawn DLAs during insolvency may face personal bankruptcy or legal action.
If your company goes into liquidation, the DLA balance cannot be written off just like that. The liquidator will try to recover the outstanding debt, and you could be held personally responsible for repaying the loan if the company cannot.
