Ltd Companies and Director’s Loan Accounts
When you operate your small business through a Ltd Company, you’ll need to get used to lots of new vocabulary around Accountancy.
One of the most frequently misunderstood terms (and areas of Accountancy) for a small Ltd Company is the Director’s Loan Account.
But don’t worry – we’re here to break it down for you!
Imagine for a moment that you’re an employee of another business. The boss has asked you to pop out to buy some milk and teabags but the petty cash tin is empty. So instead, you use your own money and hand the boss the receipts for the purchases when you get back to the office. Then your boss reimburses you and everyone is squared up and happy.
That’s basically how a Director’s Loan Account works – except that you are both the employee and the boss.
When you are the Director of a small Ltd Company it won’t be unusual for you to pay for items for the business out of your own pocket. Either because it was a pre-startup cost and the business didn’t have a bank account yet, or the company card wasn’t to hand when you needed to subscribe to a service on a Sunday evening (gotta love those small business hours!)
Whatever the reason, money that is owed to you by the company is recorded on the Balance Sheet in something called the Director’s Loan Account.
How do Mazuma help?
When you use our monthly Accountancy subscription service, our Accountants will calculate this figure and display it for you on your reports. You can then draw this money out of the company tax-free whenever the cash is available. Think of it as the company repaying you money that it owes you.
When our Accountants reconcile your business bank account and business credit card statements, they’ll match up all of the items from your invoices and receipts to the bank statements. If we’ve received receipts that we cannot see as being paid for from the business bank account, it’s most likely that you’ve paid for them from your own pocket – so we record them into the Director’s Loan Account for you, so that you can see what the business owes to you. We’ll also tally up your mileage and use of home as an office and record that in there for you too – so that it’s all in one place.
When you withdraw money from your company, we’ll match that money off against the balance on the Director’s Loan Account first – so that you keep your tax bill as low as possible, and to make sure that the company doesn’t owe you any money.
But what happens if you take out too much money from the company?
Then you may end up with a problem.
Money taken from a Ltd Company can only be taken out via a salary, a dividend or a repayment of a Director’s Loan Account.
If you don’t have enough distributable profits left to take money out, and you don’t pay yourself a salary, then you may end up with an overdrawn Director’s Loan account which could end up with you needing to pay additional taxes.
At the end of an accounting period, if the director owes the company money (ie the account is considered overdrawn), and the company is something called a close company (broadly speaking, one that is controlled by five or fewer shareholders), there will be tax consequences to consider. Yikes!
The s 455 charge
The legal and tax bit – A tax charge will arise under the Corporation Tax Act 2009, s 455 where a director’s loan account is overdrawn at the end of the accounting period and remains overdrawn nine months and one day after the end of that accounting period. The tax charge is the liability of the company and is calculated as 32.5% of the amount of the loan – that’s quite a high tax charge and worth noting that the rate of the charge is equivalent to the higher dividend rate.
Jess is the sole director of her small Ltd Company. The company’s financial year end is 31st March.
On 31st March 2021, Jess’ Director’s Loan Account is overdrawn by £20,000 and it remains overdrawn by this amount on 1 January 2022 (the date that the corporation tax for the period is due to be paid). The company must pay a tax charge under s 455 of £6,500 (£20,000 @ 32.5%).
That’s quite a big tax hit to take and one that is potentially avoidable with some careful planning by the Accountants at Mazuma.
Can you avoid the tax charge?
Even if the loan account was overdrawn at the end of the accounting period, the section 455 charge can be avoided if the loan is cleared (or paid off) by the corporation tax due date of nine months and one day after the end of the period. This can be done in various ways:
– the director can pay funds into the company to clear the loan;
– the company can declare a dividend to clear the loan balance;
– the director’s salary can be credited to the account to clear the loan balance; or
– the company can pay a bonus to clear the loan balance.
It’s important to remember though, that with the exception of the director introducing funds into the company, the other options will trigger their own tax bills – so you need to think carefully about which action to take.
Two further points are also worth considering here:
– Clearing the loan may not always be the cheapest way of dealing with the issue and perhaps it’s worth paying the charge. For example, if the tax on a dividend or bonus credited to clear the loan is more than the section 455 charge, then it would not necessarily make sense to clear the loan at this time.
– Once the loan is cleared, the s 455 tax is repayable. This happens nine months and one day after the end of the tax year in which the loan is cleared.
It should also be noted that anti-avoidance rules apply to prevent the director clearing a loan shortly before the section 455 trigger date, only to re-borrow the funds shortly afterwards again in the next financial period. So you can’t just keep accruing a loan and then paying it off, only to accrue it again quickly afterwards.