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Directors’ loan accounts – friend or foe?

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Thursday March 10, 2011 at 10:00am

Directors’ loan accounts are used widely in private companies yet they are subject to a considerable amount of confusion, not least the tax implications arising in certain circumstances.

It is very common for a director to lend money to, or borrow funds from, their company. As many directors are also shareholders in the companies they operate it is easy for them to assume that funds can be taken out of “their” company without keeping appropriate records or properly considering the tax implications. However, it is important to remember that a company are a separate legal entity from the directors and shareholders and it is essential that personal funds/assets are clearly distinguished from funds/assets belonging to the company. Any transactions between a director/shareholder and their company will have varying implications and tax treatments and therefore need to be carefully recorded, which is often dealt with via a director’s loan account.

Director’s loan accounts can be a simple way for both companies and directors to obtain funding without the need to involve a third party. However, it is important to understand the consequences and effects of any transactions undertaken. It is also important that all transactions are correctly recorded as and when undertaken and that directors and their companies are aware of the running balance at all times.

Director’s loan accounts and how they work

A director’s loan account can in practice be any form of account or bookkeeping record and is operated like a current account with a bank showing the running balance between the director and the company. The account will show various credits (i.e. monies owed to the director from the company) such as undrawn salary, undrawn dividends, money put into the business and expenses paid on behalf of the business (not reimbursed in cash) etc. Monies withdrawn by directors from the business for non business purposes will be shown as a debit to the account and reduce the running balance.

When the balance is, in overall terms, a credit figure, i.e. in net terms the company is holding funds for the director, then this is classed as a loan to the company from the director. When in net terms the director has borrowed funds from the company there will be a debit or overdrawn balance.

Timing is everything. Unpaid remuneration or dividends can only be credited to a director’s loan account at the point at which such remuneration (received in an individual’s capacity as a director) or dividends (received in an individual’s capacity as a shareholder) is formally voted. The Companies Act sets out the appropriate procedures but under no circumstances can remuneration or a dividend be said to have been voted at some point in the past, i.e. any credit arising from the voting of remuneration or a dividend can only take place on the date on which the appropriate resolutions are passed which in respect of remuneration would also be the date on which a PAYE/NI liability would be triggered.

Where a director has introduced funds to a company such that the company owes money to that director then generally the consequences are fairly straightforward. The director is even allowed to charge interest to the company, at a reasonable rate. Whilst taxable, interest paid to directors can be a useful form of profit extraction as no liability to National Insurance arises.

Where a director has effectively had a loan from the company, strictly speaking this arrangement should be formally approved by the shareholders. If there is an overdrawn balance then the director/shareholder has an obligation to repay the balance at some point, either by introducing funds to the company or from credits which will be due from the company to the director at some point in the future. Difficulties can arise where future credits are anticipated but do not materialise, often as a result of the failure of the company.

Overdrawn director’s loans can also give rise to tax charges relative to the benefit-in-kind of having a cheap or interest free loan. Small loans (i.e. those of £5,000 or less) are ignored for this purpose but all other loans must be disclosed and a benefit-in-kind calculated.

Writing off a Directors loan as a bad debt can itself bring difficulties and cause HMRC to look closely at the affairs of the business.

So are directors’ loan accounts a friend or a foe? Treated correctly they are a very flexible tool for both the business and the individual director. But make sure you are accounting correctly for them and consider all the tax implications.

Andy Parker

Chartered Accountant 

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Parker Chartered Accountants and Financial Advisors is the trading name for Parker Business Development Ltd (Registered No. 4116664), Parker Tax and Trust Ltd (Registered No. 06950353) and Parker Financial Planning LLP (Registered No. OC347027). Parker Financial Planning LLP is authorised and regulated by the Financial Conduct Authority. All companies are registered in England and Wales – registered office contact details here