Director’s Loan Account and Dividends

Understanding the details of a director’s loan account is essential for proper financial management and compliance. As a director, you need to know the implications and risks of borrowing money from, or lending money to, your company. This article highlights what is a director’s loan account, how they work, and what to look out for.

What is a Director’s Loan account?

A Director’s Loan Account, or DLA, is an account that reports all transactions between the director and the company. Amounts due to the director from the company should be recorded in the company’s books as a creditor while the amounts due from the director to the company should be recorded as a debtor.

What is considered to be a director’s loan?

A loan to a director is any payment that cannot be categorised as salary, dividends or legitimate expenses. In other words, it is money that a director borrows from the company, and will eventually have to repay.

How is a company loan to a director approved?

For loans of more than £10,000, shareholder approval must be given beforehand. Often a director is also a controlling shareholder, so the approval is more a formality rather than a legal issue.

Does a benefit in kind arise on an overdrawn DLA?

If the loan is greater than £10,000, a benefit in kind will arise on the cash equivalent of the amount of interest that would be payable at the official rate.

A benefit in kind will not arise if the loan does not exceed £10,000 or the director is paying interest on the loan at the rate recommended by HMRC.  

Are there any other tax implications on an overdrawn DLA?

A director’s loan must be repaid within nine months and one day of the company’s year-end. Any unpaid balance at that time will be subject to a 32.5% corporation tax charge (known as a Section 455 tax charge).

Once the loan is fully repaid, the tax can be claimed back. However, this can be a lengthy process.

What are the consequences if the loan is not properly approved?

Potentially serious consequences can result if the proper approval process is not followed, particularly if the loan is for more than £10,000. Section 213 of the 2006 Companies Act advises that the loan may be considered ‘voidable’ or invalid.

Taking out a director’s loan ‘by accident’

It is possible to take out a director’s loan inadvertently, by paying yourself an illegal dividend.

A director may choose to take much of their income in dividends, as this is generally more tax efficient than a salary. However, dividends can only be paid out of profits, so if the business has got distributable reserves (usually arising from retained profits), then legally no dividends can be paid.

If management accounts are not prepared correctly, then a profit may be declared by mistake and illegal dividends be paid. This should then be considered a director’s loan, recorded in the DLA and repaid within the nine-month deadline.

Can I lend money to my company?

It is possible for a director to lending to the company (e.g. to fund its ongoing activities or buy assets) but only a temporary basis.

If a director decides to charge interest, then any interest that the company pays is considered income and must be recorded on their self-assessment tax return.

The company treats the interest paid as a business expense and must also deduct income tax at source (at the basic rate of 20 per cent). However, the company will pay no corporation tax on the loan.

What are the consequences on the overdrawn DLA if the company goes into liquidation?

Operating an overdrawn DLA during the time leading up to insolvency, and when the company enters liquidation, can result in serious financial difficulty for directors on a personal basis. If it is later found that a director took a loan from the company that couldn’t be financially supported at the time, the repercussions can be severe.

The liquidator’s overall responsibility is to the company’s creditors. They have a duty to realise the business’ assets and collect all debts for the benefit of creditors. Although there is a legal separation between you and the company, directors’ loans cannot simply be written off when the business experiences financial difficulty. They will seek repayment of the loan and pursue the director personally through the courts which can lead to bankruptcy.

Under these circumstances, more directors are likely to face financial recovery action and face scrutiny by the Insolvency Service. Whenever a company enters into liquidation, an investigation commences to understand the reasons for the company’s decline. If one of those reasons is an overdrawn DLA, you could be held partly responsible for the company’s financial situation.

What are the consequences on illegal Dividends if the company goes into liquidation?

Dividends are only payable from profits and consideration of the company’s future profitability. Yet if directors pay dividends as insolvency approaches and even when insolvent, liquidators can, and do, seek to reclaim such dividends from the directors personally, because such dividends are illegal. Financial recovery action is part of a liquidator’s responsibility.

If the profits are not there to allow for the dividend, then any such dividend will be illegal and will be investigated at liquidation.

Are you able to write off the DLA balance if the company goes into liquidation?

Unfortunately, the debt you owe to your company cannot be written off. However, the liquidator will take all steps necessary to recover the money.

Director’s loan checklist

Here is a short summary of things to remember if you are considering borrowing money from your company or lending to it:

• Take out director’s loans only when absolutely necessary (i.e. explore all other options first).
• Repay your director’s loan within nine months and one day of the company year-end.
• Aim to borrow less than £10,000.
• If you borrow £10,000 or more, you must report it on your self-assessment tax return and the company must treat it as a benefit in kind.
• Wait at least 30 days between taking out different director’s loans
• If you lend to your company, ensure that both you and the company use the correct tax treatment.
• Do not allow your DLA to be overdrawn for extended periods.
• Be certain that your company has distributable reserves (retained profits) before declaring dividends.
• It is important to be fully aware of the balance on DLA, and to take the correct action if it becomes overdrawn. Understanding your responsibilities in this respect can safeguard you from personal liability should the company decline to the point of liquidation.

We always recommend taking independent professional advice. Get in touch with your accountant for more tailored support.