Directors Loan Account (DLA) is an account on the company financial records that reports all transactions between the director and the company. In other words, it is a virtual account which exists only in your accounting records as a way to keep a track on the flow of money between you as an individual and the limited company. Simply put, a director’s loan account is a record of company financials where all transactions between the director and the company, apart from salary and dividend are documented.
Directors Loan is not only related to the money exchange between the director and the company but also extends to his close family members as well i.e. if a payment is made to the director or to any of his close family members and it is not part of his remuneration or is not an allowable expense for the company, then the payment must be set against directors loan account.
If we talk about sole traders or for that matter partnership, withdrawing money from the business is a straightforward process and has less or no tax implications, withdrawing or crediting money from or to the company give it a different angle altogether as it becomes a separate legal entity and thus it requires thorough consideration.
Your directors loan account is in credit and you are the creditor to the company when you have put your own money into the company and this is an ideal situation for any close company( having not more than 5 shareholders/directors),however, the complexities arises when you withdraw/borrow money from the company fund and your directors loan account becomes overdrawn in due course of time. Anyone who has worked with a close company is well aware of the problem of unclear boundaries and like everywhere else in life, it is the often the simplest of the things like confusion of business and private expenses, which creates trouble.
However, having an overdrawn directors loan account is not the end of the world, provided you or your accountant has kept track of the money owed to the company and you can afford to repay it or offset it within allowed time period which is 9 months and 1 day of your accounting year.
There may be a time when you have to put money in the company’s fund from your personal fund and this amount should be recorded in the company’s book as a creditor and at times you withdraw money from company’s account for your personal use and this amount should be recorded in the company’s book as a debtor.
Taxes To Be Considered While Working With Directors Loan Account:
There are 3 taxes to be considered while working with Directors Loan Account, which includes:
- Corporation Tax – S455 Tax
- Self-Assessment Tax – Higher Rate Tax On A Dividend
- PAYE - Benefit in Kind On A Director’s Loan
As A Creditor – Your Company Owe Money To You:
You, become a creditor in your company books when you lend money to company’s fund if and when required for smooth transaction of your business. When you do this you are making a loan to the business. Even if you don’t put any money to the company’s account, you can still make a loan to the company if :
- You have made any expense from your personal fund on company’s behalf. For example, if you have made a purchase of items worth £1000, then company owes this much amount to you.
- You choose not to pay yourself the salary during tough times.
As a creditor, you can choose to withdraw this money from company fund at any point of time provided your company funds should have that much spare money to pay you off.
When you lend money to your company, you can choose to charge interest on the money you have lend and the interest will be counted as a business expense for the company as well as a personal income for you. However, this income needs to be mentioned on your personal Self-Assessment Tax Return. Situations like this, where you would be required to fund your company arises when company fund is running low on cash so it is in company’s interest that it pays you the interest without any income tax at the basic rate of 20%. However, it has to pay income tax to HMRC every quarter and submit Form CT61 ( Corporation Tax 61) .You can either fill it online or contact HMRC on their helpline number for the same on :
HMRC Shipley Accounts Office
0300 051 8371
Monday to Thursday, 9am to 4.30pm
Friday 9am to 4pm
As A Debtor – You Owe Money To Your Company:
You, become a debtor in your company books when you borrow money from company’s fund, which is not part of salary, dividends, loan repayment and this is when you are borrowing money from the company via director’s loan. Adequate care must be taken into consideration when borrowing money from the company for the simple reason that it can have implications for corporation tax and national insurance.
For example, if you are using your private car for work purpose and have scraped it. You can claim its repair cost against the company but at the end of the day, it was your private car so we would have to put the repair cost, let’s say £300 in the directors loan account as money owed by you to the company. Amount £300 for a scraped car is not a big amount at all to be worried but for all you know and before you realize it can mount up if you make it your practice.
Occasionally, directors will take payments in excess of the funds introduced into the company and therefore the director becomes a debtor, commonly known as an overdrawn director’s loan account and to stop this practice by the directors, there are certain anti-avoidance rules made by a close company applicable to its directors, such as:
Corporation Tax has to be paid on any loans to the directors which has not been repaid within nine months and 1 day after the end of the accounting period in which loan(s) are made. For many years tax rate on directors loan account has been 25%, however it has been increased to 32.5% in the financial bill 2016 after introduction of dividend tax (7.5%).
So hypothetically, you owe amount £100,000 to your company before 4th April 2016, and then it will attract corporation tax of £25,000 however, for the same amount, applicable corporation tax on or after 6th April 2016 will be £32,500.This measure was announced in Budget 2016 and introduced through the Finance Act 2016.
If you are unable to repay the overdrawn loan amount within nine months and 1 day time period from your company’s accounting year, then HMRC will charge interest on the loan amount which will keep on accumulating until you pay the Corporation Tax (S455 tax) or loan amount is repaid. Once loan amount is repaid, you can claim relief from HMRC against S455 tax however the interest paid on it-which is 3.25%.
Once you have repaid the loan amount, your company can reclaim the Corporation Tax paid on it (minus the interest) within 4 years or 6 years if the loan was repaid on or before 31st March 2010.
In Case Your Company Is Reclaiming Corporation Tax Within 2 Years: If the reclaiming of corporation tax is being made within 2 years of the end of the accounting period when loan was given to the participator, you have to use Form CT600A at the time of preparing your Company Tax Return. Same is to be used when you are amending your Company Tax Return Online. However, you have to use Form L2P in case you are reclaiming corporation tax in a different accounting period than the one when the loan was taken out or you want to amend your Company Tax Return in writing. In your Company Tax Return, you can mention how you want the repayment to be done by HMRC. You can use the amount to pay your next Corporation Tax or Late Filing Penalty or PAYE Tax or Vat Tax, if applicable. You can also get this amount paid to your company’s bank account.
If your company has paid a great amount as corporation tax, HMRC will repay what you have overpaid along with the interest on it, which is 0.5% at the time of writing this article.
In Case Your Company Is Reclaiming Corporation Tax After 2 Years: If you are applying to HMRC for reclaiming your corporation tax after 2 years of the time period when the loan was taken, you would need to add Form L2P and add it with your Company Tax Return, either online or by post. If you are opting postal way, you would need to include certain information/details including:
- Unique Taxpayer Number (UTR) number.
- Start and End date of the accounting period in which loan was taken along with the date when the loan was taken.
- Start and End dates of the accounting period in which loan or part loan was repaid/released or written off.
Irrespective of how and when your company is reclaiming Corporation Tax paid on the loan given to you, HMRC will repay your company either by sending a cheque at your registered office address or they can use the details you have mentioned in your latest Company Return.
Overdrawn Directors Loan Account:
An overdrawn director’s loan account takes is a situation where director has taken more money from the company’s fund than he has put in, minus salaries and dividends. Overdrawn amounts are counted as assets on the balance sheets of the company until they are repaid. Being overdrawn is not a problem for a company or for its directors as long as all records are in order and payments are being done within 9 months of the company’s financial year end. An overdrawn directors loan account is effectively an interest free loan.
Debts pertaining to an overdrawn directors loan account is also called as “loans to participators” for corporation tax purposes and can have various implications on the company as well as on the director(s):-
- Corporation Tax Charge – S455 – When a close company makes a loan to its director(s), the outstanding amount at the end of its accounting year will attract corporation tax at rate at 25% on the outstanding balance and at the rate of 32.5% for loans made on or after 6th April 2016 and its commonly called as Section 455 (s455) tax under Corporation Tax Act 2010. For example If the balance of the loan from company to director was £10,000 as at 5 April 2013, and was £5,000 as at 6 January 2014, tax would be liable on the remaining £5,000 i.e.£1,250.
S455 tax is reclaimable that also makes it temporary in nature, which means that if a repayment of the loan is made within 9 months and one day of the accounting period, company can claim for the relief to Her Majesty’s Revenue & Customs ( HMRC ), however disclosure has to be made in the company’s tax return.
In case you are planning to take a loan from your company then one thing which you have to keep in mind is the date of the loan for you to have maximum time at your end for its repayment.
- Benefit in Kind (BIK) – The second and important implication of an overdrawn directors loan account is Benefit in Kind, also known as BIK.
If the loan due on the director is more than £5000 during 2013-14 and £10,000 from 2014-15 onwards, it can trigger a benefit in kind. And as mentioned above, overdrawn directors loan account is an interest free loan, so the benefit equates to the interest that would have been due and calculation of which is stipulated by HMRC. If the loan exceeds £5,000 at any time in the year then a benefit in kind has to be calculated on the director’s form P11D.
However, there are certain cases under which no benefit in kind arises, such as:
- Loan amount is considerably small i.e. under £10,000 in one financial year.
- Loan is used by the director for various qualifying purpose like buying an interest in a partnership.
If interest on a loan (at a commercial rate) is not paid to the company by the director, the director is deemed to have received a “Benefit In Kind (BIK) and the value of that benefit is taxed on the director at the tax rate payable by that director. Currently the interest benefit is calculated at the rate of 3% per annum (HMRC “official rate”) for the period of the loan – whether it’s repaid within the nine months period or not. To avoid a BIK charge the director can make an interest payment to the company or the interest amount can be debited to the DLA in the company accounts. The company is required to notify HMRC of all the BIK’s received by it’s directors and employees (with minor exceptions) on a form P11d by 6th July each year. Incorrect and late returns could trigger a penalty of £3,000 each. All BIK’s are based on the tax year and not the company’s trading year and therefore it’s not always easy to calculate the actual beneficial interest by the P11d deadline date. Consideration should therefore be given to charging interest on directors overdrawn loans within the company’s accounting year to avoid a potential costly omission or error on the P11d. Interest can either be physically paid or debited to the Directors Loan Account.
An overdrawn directors loan account could result in a S455 tax or a benefit in kind or both.
Outstanding DLA Balance * HMRC Official Interest Rate = BIK.
BIK* 13.8% = Class 1 NIC payable
We know that the official HMRC interest rate is 3.25% for 16/17 and if we use the example of an £11,000 overdrawn director loan account the calculation is as follows:
£11,000 * 3.25% = £357.50.
£357.50 * 13.8% = £49.36 Class 1 NIC payable via P11d
Self Assessment Tax
There is also an income tax charge via Self Assessment on the value of the BIK. If you are a normal rate taxpayer this will be 20%, but if you are higher rate 40% will apply. Using our £11,000 example, a higher rate taxpayer would be charged £357.50 * 40% = £143.
Total cost to borrow £11,000
S455 Tax (reclaimable) – £2,750
Class 1 NIC Charge – £49.36
Self Assessment Charge – £143
Total cost: £2,942.36 (of which £2,750 is reclaimable)
- For HMRC, it is not just you whose loan is considered against overdrawn directors loan account but also of your associates, which can be your spouse or civil partner, business partner, a relative, a trustee or a loan creditor. So, if your company is lending them as well, then it is counted as a part of your directors loan and not as an individual/separate loan.
- Bread and Breakfasting (Anti-Avoidance Rules) – As a normal practice, directors use to pay off the loan amount within 9 months 1 day of the account period in which loan was taken and then taking it back out again the very next day to avoid the tax charge and this practice is commonly known as bed and breakfasting. However, HMRC has come up with new set of rules to deter the directors from their bed and breakfasting practice, such as
- 30 Days Rule : As per this rule, if amount repaid is taken out within 30 days then it will be considered as loan not paid i.e. if repayments totaling £5,000 or more and new loans totaling £5,000 or more are made within 30 days period of repayment, then it will be considered as new loan.
- Arrangement Rule (Outside 30 days period) : Under this rule, a director can enter into an arrangement with a bank, where he can borrow from his personal saving accounts on a short-term or temporary basis for repayment of his loan before taking out a new loan from the company at a later date.
What If You Are Not Able To Repay The Overdrawn Directors Loan Account? – Liquidation/Insolvency Of The Company:
Director withdrawing money out of his company when the business is progressing well is quite a normal practice all around the world, however the problem arises when they struggle to pay back these amounts when trading takes a turn for the worse. In case too much is withdrawn/borrowed and the director is not able to repay it within time, then company might be forced into liquidation because of its inability to pay to its creditors. Because if you are unable to repay over overdrawn amount back to the company, company will not be able to make the pay out to the creditors and it is then the duty of the liquidator to assess the overdrawn amount of directors loan account and release as much funds as possible to the creditors.
When a limited company becomes insolvent, first thing they should do is to stop trading immediately because it would be unlawful to continue taking credits with the suppliers being fully aware that the company might not be able to pay them back. The liquidator will look into the overdrawn DLA and other assets and assess if they are sufficient enough to release the payments to the creditors. Failing to do so, he can take legal action against the director to the extent of declaring him bankrupt.
In such case, you should stop withdrawing any kind of bonuses or dividends from the company, especially when your company is not making any profit. Because doing so will only be an add on to your already existing misery and overdrawn directors loan account.
Warning Signs That Your Company Could Soon Be Insolvent:
You should watch out for red flags indicating towards insolvency of your company, such as:
- Lack of Cash Flow: If your company has got no investors to invest, it means that your company is likely to face cash crunch situation soon, if not already.
- Pressure from the Creditors, HMRC etc: If you are dreading one more call from HMRC, Creditors, Bank, Mortgagors etc then you are heading towards insolvency of your company.
- Maximum Borrowing (Ceiling Borrowing): If you have reached the limit of your bank overdraft and have been refused for further borrowings.
- Inability to pay salaries: If the likelihood of meeting the wage bill is slim then insolvency is inevitable.
Above are the possible signs/indicators of insolvency but there are specific tests that you can conduct to understand the gravity of the situation, such as:
Company Insolvency Tests:- A company is said to be insolvent if its liabilities exceeds its assets or if it cannot pay its debts as they fall due.
Cash Flow Tests:- This test is to determine if company is able pay its debts which are due at present and also to those which are likely to get due in reasonably near future (which depends on the nature of your business). In a situation like this, it’s the creditors whose money is stuck because technically you have spent their money so when they realize that your company is going through cash crunch situation and you are consistently behind their payment deadlines, they impose 30 days deadline for the payment and in case you regularly fail to adhere to the 30 days rule and paying after 40 or 50 days for example, then it is quite likely that you are heading towards insolvency in full speed.
So you have realized that you are not able to pay your creditors money on time. Take it as first sign of fast approaching insolvency and you start looking for strong signs like failure to meet a 21 day Statutory Demand for payment of more than £750 and failure to obey terms of a court order.
21 Days Statutory Demand: If you owe £750 or more to one or many creditors and are not able to repay it then they make opt for sending 21 days statutory demand notice demanding payment. This is basically last resort for secured creditors like HMRC in a hope that debtor(s) will succumb to pressure and the threat of liquidation. Once you have received the 21 days statutory demand, you should check all the elements of demand including the legitimacy of the specific debt and if the sender has followed legal channel. Generally, you will be having 18 days at your end to take an action on it, Failing to do so can lead to one or many serious consequences, such as :
- Creditor can approach the court to wind up your company stating his reasons of non-payment as mentioned in the statutory demand. Once he files winding up petition, it will be advertised in the London Gazette and since banks keep a tab on the notice of insolvent companies, bank account of your company will be sealed/frozen.
- Words spread like wildfire and other creditors may hear about your financial situation and begin their own legal action which will put you in a downward spiral mode.
- After waiting for 7 days, the court can issue winding up order which means your assets will be assessed for the repayment to the creditor and thus it will set the ball rolling for the liquidation of your company. Once it is done, your business will cease to exist.
However, certain unscrupulous creditors can use this method with ulterior motives as well and you need to be careful while you attend 21 days demand. Once this demand is made, you have to either repay the amount you owe to the creditor or you have to challenge the demand in the court and get it reversed/cancelled, called as setting aside the demand. If you manage to set aside the demand, the creditor could face accusations of abusing court process.
You can set aside the demand if one or more of the following are true:
- The amount stated in the demand is in dispute, or is less than £750
- The creditor holds security equalling or exceeding the debt
- You are paying by instalments and have not reneged on any payments
- You are owed money by the creditor
- The demand was made in error
- The creditor failed to use the correct forms and/or required method of serving the demand.
In case you manage to prove your point in the court, court will cancel the demand and the creditor will have to face its repercussions.
Next very important test to check for strong signs of Insolvency is Balance Sheet Test, which is:
Total amount of your assets will be compared with total amount of your liabilities. However to conduct this test with accuracy, it is recommended that you appoint an independent expert who is capable to see everything as a devil’s advocate and who can value your company assets while taking account of all contingent liabilities. If your assets turn out to be lesser than your total liability then you would be unable to pay back to your creditors and thus it can be said that your company is on the verge of insolvency.
There might be situations where Balance Sheet Test shows positive result whereas Cash Flow Test shows negative result. That is why it is important to view the result as a whole and independently.
It is quite normal to get caught up in the day to day running of the company and miss these red flags and signs of approaching insolvency and it is always easy to blame one or other department for cash flow problems. However it is always good to take a wider or rather top view of the your operations which will help you in preparing yourself and your company for a situation as serious as insolvency.
And in the worst case scenario, if you have missed or overlooked these signs, you still have some hope left if you take right steps on immediate basis and there is nothing better than taking an expert opinion on company insolvency procedures from a licensed and established insolvency practitioner.
Can An Overdrawn Directors Loan Account Be Written Off?
A company may decide to waive off/write off loan amount owed by a director or the participator as an overdrawn loan amount. However, like any other process, writing off the loan amount has to be done in a formal manner; otherwise the liability will be there in the company’s book throughout. In most of the cases, HMRC considers the writing off the loan under “emoluments from an office or employment” and thus ask for Class I (NIC – National Insurance) from the company and the amount written off is treated under Income Tax(Trading and Other Income) Act 2005 as a deemed dividend.
The amount of loan that is written off will be mentioned in the director’s self-assessment tax return and will be treated as dividend for the income tax purpose. However, company will not get any relief on the Corporation tax on the written off amount.
Can An Overdrawn Directors Loan Account Be Offset?
There might be a situation where two directors of the company are spouse, wherein one of them owes money to the company (debtor) whereas company owe to the another one (creditor). Both of them decide to offset the balance, however to do so, they have to formally agree in writing and documentation should be well taken care off before the balance is offset. In case, there is still balance left on one of the spouse, he/she has to follow the normal route and timeline to repay the balance amount.
Disclosure of Director’s Loan Account:
Good record keeping with regards to a directors loan account is an essential part of your business. It not only helps in right allocation of expenses/payments but also assists you in payment of right taxes on right time.
Section 413 of Companies Act 2006 provides for the disclosure of the details of any advance/credit granted by the company to its directors. Certain details are to be mentioned in the disclosure statement, including:
- Amount of loan which is granted during that year.
- Interest Rate Applicable
- Main condition under which loan is given.
- Any amount repaid/written off.
- Total amount of interest charged.
Any taxable benefits arising on a loan to a director will be reported on the P11d form for that tax year. S455 tax resulting as a result of a loan made to the director has to be reported as a part of the company’s tax return but if it is reclaimed then it has to be mentioned separately from the tax return.
You started with this new and innovative idea of yours and converted it into a business by forming a company and registering it with Companies House, which in turn registers it with HMRC.
When you started, everything was well thought of and you were always ready with an exigency plan for tough times, if arises. During initial days, there was a thin borderline between what your personal expense is and what business expense is and everything was well accounted for in your company’s book either by you or accountants appointed by you. As a matter of normal practice, you at times put your money in to company’s fund and at times you borrowed some from the same with a clear intention of repaying it within allowed time period to avoid any sort of tax and interests on it. But then the wheels were already rolling and this once in a while practice became your second nature and by the time you realized what has happened, the directors loan account was already overdrawn.
To avoid such situations, it is recommended to hire services of a well-established accounting firm with years of experience and DNS Accountants is an expert group of taxation and accounting which offers accounting and taxation services at a very nominal rate. They have well –read and experienced team of CAs/ACA who have a strong track record of guiding/supervising number of directors of companies with their directors loan management account.
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