You might have heard your accountant mention a “director’s loan account” in your limited company. What do they mean, and is this something you need to be concerned about?
Emily Coltman FCA, Chief Accountant to FreeAgent, explains more.
What is a director’s loan account?
When you’re operating through a limited company, you need to remember that the company is a separate legal entity from you, even if you are its only director and shareholder. That means that the company’s money is not your own money!
In simple terms, a director’s loan account will come into being if you either owe money to the company, or it owes money to you.
Why might the company owe you money?
You might spend your own money on business expenses, such as taking the train to visit a client and paying for that ticket on your personal credit card. So long as these are bona fide business expenses, the company can pay you back for those without any extra tax being incurred by either party, you or the company.
Until it’s paid you back for those expenses, the company owes it to you – so there will be a director’s loan account showing that money’s due to you. It’ll be a creditor, a liability, on the company’s balance sheet.
Other reasons why the company might owe you money include:
- You travelled on company business in your own car.
- You transferred into the company one or more assets that belonged to you, like a computer.
- You changed your business from a sole trader to a limited company, and your accountant calculated that your business was worth more than the value of all its assets. This extra amount is called “goodwill”.
- The company has declared a dividend to its shareholders but not yet paid that out.
- The company has not yet paid your wages.
Why might you owe the company money?
If you take out more than the company owes you, then you’ll owe that money back to the company. This is called “an overdrawn director’s loan account”, and it’ll show as an asset on the company’s balance sheet.
If it’s an asset of the company, isn’t that a good thing?
Not in this case!
Overdrawn director’s loan accounts attract extra tax in two potential ways.
If you owe the company money and you don’t repay it by nine months after the company’s year-end, then you’ll have to pay income tax on that loan, because you’re deemed to have received it as income.
That’s called “section 455 tax” because that’s its legal reference number. The s455 tax charge is currently 33.75%.
Also, if you owe the company more than £10,000* at any time during the year, that’s a benefit you’ll have to pay tax on, which would have to be reported on form P11D and on which the company would also have to pay extra NI.
To avoid this, do your best to make sure that if there is a balance on your director’s loan account, it’s the company owing money to you, and not the other way round!
Emily Coltman FCA is Chief Accountant to FreeAgent, which provides the UK’s market-leading online accounting system specifically designed for small businesses and freelancers. Try it for free here.