Generally, there are no tax implications when a sole trader or partnership puts cash in or takes cash out of a business.
A company, on the other hand, is a separate legal entity and any cash assets held by the company belong to the company and not the director/s. Any cash drawn by the director/s that is not part of a remuneration package or a repayment of business expenses is considered to be a directors loan.
The directors loan account is simply a record of all transactions between the company and the director/s. You may also hear it being referred to as a Director’s Current Account or a DLA. It’s the same thing. The amount owed to or from the director. If there are multiple directors in the business, each will have a separate director’s loan account in the balance sheet. The DLA is a balance sheet account of course because the balance is either:
- an asset – money owed to the company or,
- a liability – money owed to the director.
DLA’s can be made up of:
- monies drawn down by the director
- personal bills paid by the company
- net amounts due of salaries and dividends not yet paid to the director
- reimbursements of expenses paid by the director
If you loan money to your company then your directors loan account is in credit – the company owes you, the director – and the liability will be shown in the balance sheet.
Say you put £10,000 into the company on the 31st January. This injection of cash will show as a balance owed to the director and can be drawn down at any time without any tax implications.
|31-Jan- xx Being an injection of cash into the company|
|Directors Loan Account||10,000|
If you take cash out of the business, then your directors loan account is overdrawn – you owe the company and the asset is shown in the balance sheet until you repay it.
Say you take £10,000 out of the company on 31-January. The loan from the company will show as a balance owed to the company from the director. If this were the only transaction in the directors loan account it is considered to be overdrawn.
|31-Jan- xx Being a loan of £10,000 to the director|
|Directors Loan Account||10,000|
A Typical Director’s Loan Account
In many small owner-managed businesses, the director/s will treat the company bank account as their own and draw cash from the company as they need it to cover their personal expenses. Director’s loan accounts can get quite busy as the cash withdrawals accumulate over time.
So, what can we do to reduce the balance of the director’s loan account?
- Pay the director a salary. A directors payroll can be run monthly or annually to offset some of the cash payments made to the director: See: Tax Efficient Directors Salaries
- Make sure any business expenses paid personally are claimed. See Effective expense claims management
- Claim all business mileage.
- Claim for the use of home office. See: Director renting office space to the Company
- Pay a dividend: Paying dividends
- Sell any personal assets used by the business to the business.
A typical directors account may look like this:
A sample directors loan account – 1st to 31st Jan- xx
Bob is an owner-manager director and draws £250.00 a week to pay his personal expenses. His accountant runs a directors payroll and at the end of the month, Bob puts a claim in for his personal expenses but doesn’t draw the cash. He allows his expenses to partly offset the cash that he has drawn during the month.
|Balance brought forward from 31 Dec||1,000.00|
|07-Jan Cash withdrawal||250.00|
|14-Jan Cash withdrawal||250.00|
|21-Jan Cash withdrawal||250.00|
|25-Jan Directors payroll – net salary payable (owed but not actually paid in this example)||857.98|
|28-Jan Cash withdrawal||250.00|
|31-Jan Business Expenses claimed – stationery paid personally||25.00|
|31-Jan Business Mileage claimed – 150 miles at .45p per mile||67.50|
|31-Jan Use of home office (calculated per HMRC approved method)||80.00|
|Balance carried forward as at 31 Jan||969.52|
In this example Bob still has an overdrawn loan account – he has drawn more out in cash than he is owed.
It’s perfectly acceptable to pay directors salaries and expenses as they arise or declare a monthly dividend (assuming the company is sufficiently profitable) to clear the DLA each month or quarter. This does require a little more admin time and effort but means that you will know exactly where you stand in terms of personal earnings and your business accounts.
Monitoring the DLA
Bob, being the wise and savvy director that he is, will monitor his DLA monthly to make sure that he understands how much in debit or credit he might be. By processing a monthly payroll and posting his expenses as he goes – he will have a clear picture of how those expenses will impact his profit and loss account and whether or not his DLA is likely to be overdrawn at the year end.
Accounting for the DLA at Year End
There are only three positions that the DLA can be in at year end:
- Debit balance – i.e. overdrawn. The director owes the company. An overdrawn DLA is effectively an interest-free loan to the director and can have serious tax implications. See: Overdrawn directors loan account?
- Nil balance. Great!
- Credit balance – i.e the company owes the director. There are no tax implications for the director but if you do frequently lend money to your company – do make sure your advance is protected. Do you have a formal loan agreement in place and consider charging interest until the loan is repaid.
Clearing the DLA at Year End
There are several options available to clear an overdrawn directors loan account.
- Profits permitting, declare a dividend
- If there are not sufficient profits in the business to pay a dividend, consider paying a bonus. This will create a tax and NI liability but may be preferable to having an overdrawn DLA
- Cash repayment of the overdrawn balance
Overdrawn DLA at Year End
Overdrawn directors loan accounts is effectively an interest-free loan to the director and can have quite complex tax implications:
- Corporation Tax S455 – 25% of the balance of any overdrawn directors loan account still outstanding 9 months and 1 day after the end of the accounting period. This can be reclaimed in the next accounting period if the loan is repaid.
- Loans over £10,000 (£5,000 up to 5/4/2014) – can trigger a benefit in kind reportable on a P11D creating a Class 1 National Insurance liability. If the company is charging no interest or interest below the official rate then there is a ‘cash equivalent” benefit of the interest that would have been paid if the director borrowed the money from a commercial lender.
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