Directors’ Loan Accounts (DLA)

Directors’ Loan Accounts (DLA) are an important aspect of the operation of limited companies, yet are often misunderstood. This misunderstanding can, in certain circumstances, result in unintended tax consequences.

What is a Director’s Loan Account?

As the name says, this is an account held by a director within the company, which records all the transactions between the director and the company. It is like a bank account in that it can be in “credit balance” (an amount which the company owes to the director) or in “debit or overdrawn balance” (an amount which the director owes to the company).

If the company has more than one director then strictly speaking separate accounts should be maintained, although it is usually acceptable for spouses and civil partners to operate joint accounts and if doing so, the directors should confirm the fact in writing to evidence the agreement of maintaining a joint account.

The tax implications will depend on whether the DLA is in credit or overdrawn at the accounting year end and the nature of the transaction concerned.

Why the need to have a Director’s Loan Account?

As many directors are also the shareholders in the companies they operate, it is very easy for the directors to assume that the funds can be taken out of the company bank accounts for their personal use as and when they need them. However, it is important to remember that companies are separate legal entities from their directors and shareholders and therefore any withdrawal of funds should be supported with appropriate records and only after careful consideration of the tax implications.

Director’s Loan Account having a Credit Balance at the Year End

Where directors have paid money into the company, such as when the business is starting up or to fund business expansion plans, then this creates a credit balance in the director’s loan account. Alternatively, the account is credited for payments made by a director paying business expenses personally, these credits, essentially amount to a loan to the company from the director. Where the DLA is in credit, the director can draw on the credit balance at any time without any tax or national insurance implications.

However, if the company pays interest to the director on the amount loaned, the director will need to declare the interest received on his or her personal tax return and pay self-assessment tax on that interest income. On the other hand, the interest paid by the company can be treated as a tax-deductible expense when calculating the company tax liability.

Director’s Loan Account having a Debit/Overdrawn Balance

A director’s loan account may become overdrawn for various reasons. The company may simply lend money to the director, the company may pay personal bills on the director’s behalf or the director may withdraw money in anticipation of a credit to the account, such as a dividend or salary payment.

If the DLA becomes overdrawn by more than £10,000 at any point in the tax year and the director does not pay the official rate of interest on this loan, then this will be classed as a benefit in kind (a beneficial loan) provided by the company. This would then need to be disclosed on a director’s P11D (Benefit in Kind) form, on which the company would have to pay Class 1A national insurance at 13.8%. Plus, the director, as an individual, would need to include the benefit on their personal self-assessment tax return which would be subject to income tax.

From a corporation tax perspective, if the DLA remains overdrawn nine months after the company accounting period and the director is also a shareholder, the Corporation Tax Act 2010, s455 (formerly ICTA 1988, s419) provides for a tax charge at the rate of 32.5% on the lower of the amount outstanding at the year end and nine months after the year end. This amount is payable even if the company is making a loss and there is no corporation tax due. Tax payable under section 455 is a temporary tax and it is repayable to the company by HMRC nine months after the end of the accounting period in which the loan was repaid. Once the loan is repaid, the tax is refunded and so the tax effect is nil. However, the time lag between the loan being repaid and tax being refunded can place a significant strain on the company’s cash flow.

Dealing with Debit/Overdrawn balances on directors’ loan accounts

There are a few possible ways to deal with this situation:

1) Use of dividend to clear the loan account

• Option only available if there are sufficient distributable reserves.

• Dividends are taxable in the usual way for the director. For dividends paid on or after 6 April 2018, there is a £2,000 dividend nil-rate band (i.e. dividend allowance) after which dividend payments are taxed at 7.5% up to the basic rate limit, 32.5% from the basic rate limit to £150,000 and 38.1% thereafter.

• The dividends must be authorised by the directors after suitable consideration of the company’s distributable profit.

• Dividends cannot be paid in retrospect but can be paid after the year end within the nine-month repayment period.

Dividend payment procedure:

a) Establish the distributable reserves

b) Determine the total amount to be distributed

c) Calculate the dividend per share

d) Hold a board meeting and prepare minutes approving payment

e) Make payment to the shareholders and prepare dividend vouchers

2) Use of salary / bonus to repay the loan

• This course of action may be taken where there are insufficient reserves to pay a dividend

• The tax cost may be significant as income tax and employee’s and employer’s NICs are due

• Salary is an allowable deduction for corporation tax purposes, so may reduce taxable profits or increase a loss

Optimum director’s salary 2020/21

The optimum director’s salary 2020/21 is £8,788 per annum. The reason for this is all down to the national insurance (NI) rates. The secondary earnings limit for NI in 2020/21 is £8,788 per annum. If your annual salary exceeds this amount you may need to pay NI contributions. Therefore, paying up to the secondary threshold of £8,788/annum or £732/month, means the taxpayer qualifies for the state pension but the employer, i.e. the company, does not need to pay any NI contributions. A payroll needs to be set up for payments at this level to notify HMRC for state pension purposes.

Generally, the most tax-efficient way of extracting profits is to extract an annual salary to the level of £8,788 (2020/21) and take the remainder of distributable profits as a dividend. Salaries are classed as an allowable expense, so paying yourself a salary from the business can help lower the corporation tax bill but the director’s personal tax rates on receipt need to be taken into account as well. It should also be noted that under the current furlough rules, the more you had paid yourself under PAYE, the higher the level of furlough payment you would be eligible for up to the maximum of £2,500 per month, assuming the company ceased to trade.

3) Leave the loan outstanding

• If the loan is a beneficial loan, then the recipient will continue to pay tax and Class 1A NICs on the cash equivalent of the benefit on kind

• The company will have to pay 32.5% s455 tax on the loan

• When the loan is repaid, s455 tax previously paid under the loans to participators rules will be refunded back to the company. Note that there may be a significant time lag between repayment of the loan and receipt by the company of the repayment.

4) Write off the loan

• The company can write off a loan given to the director. The amount written off is treated under Income Tax as a deemed dividend. Because it is a deemed dividend there is no requirement for the company to have available profits for distribution and the dividend does not need to be paid to all shareholders of a particular class of shares. The amount of loan written off will have to be included in the director’s self-assessment tax return. The company will not receive corporation tax relief on the amount of the loan written off.

The consequences of an overdrawn DLA if the company goes into liquidation

The liquidator can demand that director repays the amount owed to the company in order to pay the company’s creditors. The liquidator can take legal action against the director or even make him bankrupt.

Conclusion

To summarise, if the director borrows money from the company, tax is potentially payable. Good record keeping is essential as poor records could lead to the misallocation of expenses and payments and ultimately, the right taxes not being paid.