What is a director’s loan account?

This is a way of keeping track of transactions between the director and their company.

Example:

A director buys some stationery for £25 with their personal debit card. This is to be used in the director’s company but it was not paid for by the business, therefore the expense does not currently show up in the company accounts. If this transaction is not recorded in some way, the tax relief for the company on buying the stationery will be lost.

To show this transaction, we will create a “loan” between the director and the company. This will record an expense of £25 in the company accounts (meaning that this cost will be deducted from the company’s profit and tax relief will be given), and as a loan of £25 from the director to the company. The loan will be recorded as a creditor on the company’s balance sheet and will remain there until the company pay £25 back to the director in order to clear the debt.

In the above example we have looked at a director making a purchase on behalf of their company, however transactions of the opposite nature may also occur.

Example:

A director wants to buy a new coffee table for their home. The coffee table costs £250, however the director does not have access to this amount of money in their personal bank account. The company has been doing well and can afford to make the payment from their business bank account. This cost has nothing to do with the business, however the company has now paid £250 for the coffee table on behalf of the director. In this situation a loan is being made from the company to the director. The director is a debtor of the company and owes them £250. This will be recorded on the company’s balance sheet as an asset until the loan has been repaid.

In reality these types of transactions can occur very often, and care must be given to record them clearly and accurately. Over time, several transactions between the director and the company may take place. The director’s loan account (sometimes referred to as a director’s current account) is a way of keeping track of the overall amount owed.

If the company has more than one director then strictly speaking separate accounts should be maintain for each, however it is usually acceptable for spouses and civil partners to operate joint accounts.

Overdrawn directors loan account

In the second example the company made a payment of £250 on behalf of the director. If several transactions of this nature take place, the directors loan account may become overdrawn. This is another way of saying that the director owes the company money. This loan will be shown as asset on the company’s balance sheet.

This can cause a number of issues which are often overlooked by directors at the time of making the transactions.

The Company’s Tax Position (S455 Tax charge)

If the director’s loan account remains overdrawn at the year end, a s455 tax charge may be applicable.

The director is given nine months from the year end date to clear any outstanding balances. If the outstanding loan is paid off within this period, no S455 tax is payable but a report to HMRC will still be required via the company Corporation Tax Return. Any part of the loan that has not been paid back within nine months and one day of the end of the accounting period in which the loan was made the company will suffer a S455 tax charge.

The s455 charge is calculated at 32.5% of the original loan value and is paid via your companies Corporation Tax Return.

Once the loan has been repaid by the director the s455 charge can be claimed back.

“Bed & Breakfasting”

There are anti-avoidance rules to catch out those who attempt to repay the loan balance in full, therefore avoiding s455, only to withdraw the cash from the business again a few days later. The behaviour is commonly referred to as “bed & breakfasting.” This applies when a new loan is taken out within 30 days of the repayment of an earlier loan and the loan is over £5,000.

If you have a large outstanding director’s loan balance, this method of financing your activities can become a huge drain on cash flow. We advise thinking ahead and attempt to try and pay back your directors’ loan within nine months. In situations where this is not possible, ensure that you have factored the s455 tax charge into your cash flow forecast.

Directors /Shareholder Position

Rules are in place to prevent the owners of close companies benefiting from cheap financing arrangements.

A close company is defined as UK company with five of fewer directors who either:

Have control of the company, or

Together have the rights to receive the greater part of the assets of the company available for distribution.

This definition will apply to majority of small businesses in the UK.

If the shareholder (or a relative) is an employee or a director of the company, and the loans to him and to his associates total more than £10,000 at any time in the year, unless he pays the company interest at the ‘official rate’, set at 2.25% from 6 April 2020, the shareholder is taxable on a benefit in kind valued at 2.25% of the loan – and the company also has to pay Class 1A National Insurance on the same amount.

If an interest-free loan of £12,000 is outstanding for the whole of the 2020/21 tax year, assuming the official rate of interest remains at 2.25%, the employee would be taxed on a benefit of £270 (£12,000 @ 2.25%) meaning that the employee or director would pay tax of £108 if he pays income tax at 40%.

There is no employee NICs to pay, but the company would pay Class 1A NIC of £37.26 (£270 @ 13.8%). If the employee pays the £270 interest to the company, then no benefit is charged on him or the company. However, it is cheaper to pay the tax and the Class 1A (which in the case of a higher rate taxpayer comes to a total of £145.26) than to pay the interest of £270 on the loan. As a result, it can be much cheaper to borrow from the company if it has the funds available, than from a bank or other commercial lender, or to pay interest on a credit card.

Clearing and overdrawn loan account

Ways in which a director’s loan can be repaid to the business:

  • Dividends
  • Directors’ salary
  • Cash payments
  • Loan write off

If dividends are used to repay the loan, these must be declared on the director’s self-assessment tax return (even if no money is physically withdrawn from the company).

If the loan is unlikely to ever be paid off, it can be formally waived by the company. If the loan is written off, the director is treated as if the company has paid him a dividend of the amount written off. The Director must pay income tax (using the above example of £12,000 and assuming the taxpayer was a higher rate taxpayer) tax of £3,900 is payable on the loan value through their self-assessment Tax Return.

HMRC are also likely to argue the writing off the loan is “earnings” and subject to National Insurance Contributions.

If you would like to discuss this issue further or would like a free no obligation appraisal of your tax affairs, please contact AF Tax Solutions on 01323 845083 or email [email protected]

Published by
Stephanie Jenner
Senior Client Manager at AF Tax Solutions Ltd

If you would like to discuss this issue further please contact get in touch.

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