As a business owner, you may well be used to treating the company’s funds as if they are your own – you do own it after all! Treating the family to a holiday, paying the gym membership, buying personal goods like clothes – it’s easy to do when you have a card and cash in the bank.
But, at best, it’s messy. At worst, you’re building up a surprise tax bill and possibly something much nastier.
If you own a limited company, read on and we’ll explain how to avoid the pitfalls.
Firstly, what is your director’s loan account (DLA)?
Put simply, a director’s loan account is essentially a record of all transactions between the company and its directors that are not salary, dividends, or expense repayments. DLAs can include money borrowed from the company, personal expenses paid by the company on behalf of the director, or funds injected by directors into the company. It’s a way for directors to either lend money to their company or borrow from it, outside the usual payroll or dividend routes.
Key points:-
- It’s not a free-for-all! Although it might seem like a flexible way to manage finances, any money borrowed from the company needs to be repaid. Directors cannot treat the company’s money as their own.
- Record-keeping is crucial. All transactions must be accurately recorded in the DLA. This ensures clarity on whether the director is in debt to the company or vice versa at any point in time.
- Legal and tax Implications. Mismanaging a DLA can lead to significant tax implications and possibly legal issues, especially if the company becomes insolvent with an overdrawn DLA.
Overdrawn loan account = BAD!
When your director’s loan account is overdrawn, that means that you owe the business money. That might be ok in the short term, but it’s not a good idea in the long term, especially if it’s a larger sum. If anything happened to your company, it would have an asset – the money you owe to it – which you could be forced to repay. If the company went into liquidation for example, the money could be collected from you and used to repay creditors. If it’s a large sum and you don’t have the cash available, you could be forced to sell some of your personal assets to make the repayment. Not a nice position to be in.
Tax implications of an overdrawn loan account.
If your loan account is overdrawn there are 2 potential tax traps waiting for you.
Firstly, if the amount you owe to the company rises above £10,000, it can become a taxable benefit. What does this mean in practice? Either you need to submit a P11d showing the loan as a taxable benefit, or the company needs to charge interest on the loan. HMRC publishes beneficial loan interest rates and in order to take your loan out of the benefit in kind charge, the rate you apply needs to be at or above the HMRC rate.
You can find the rates here Rates and allowances: beneficial loan arrangements – GOV.UK (www.gov.uk).
As a side note, P11d’s are due to be submitted by 6th July each year for the previous tax year. If you are not very disciplined at keeping your bookkeeping up to date and wait for your accountant to help you when preparing your accounts, you might not know if your loan account is overdrawn. The penalties for filing P11d’s late can be quite stiff, so it might be more pragmatic to apply the beneficial loan rate.
Secondly, there may be S455 tax to pay. Section 455 of the Corporation Tax Act 2010 introduces a tax charge commonly known as the S455 tax. This is often referred to as a tax on the DLA, but that isn’t strictly correct.
S455 tax is a tax on participators or associates of participators of a close company.
What’s a close company?
In simple terms a close company is one controlled by 5 or fewer people. Most owner managed businesses will fall into this category. (A company which isn’t resident in the UK cannot be a close company).
What’s a participator?
A participator is defined as someone who possesses or is entitled to acquire share capital or voting rights in the company. There are some other circumstances which can qualify someone as a participator but for most owner managed businesses, the main one is owing shares.
The most likely category of associates are relatives of the participator (although there can be others, such as partners in a partnership). Relatives are defined quite specifically. Examples of relatives include:-
- Husband, wife or civil partner;
- Parents
- Children
- Siblings
Separated spouses are treated as being associated but divorcees are not. Where there is a blood relationship, other relatives can also be treated as associates. For example, half-brothers are associated but stepbrothers are not.
What does all that mean in terms of S455 tax?
If you are a director, but not a shareholder and are unconnected to any of the shareholders, then even although you have an overdrawn DLA, the company will not have to pay S455 tax. However, you will still need to consider if you have a benefit in kind.
If you are a shareholder, you don’t need to be a director for the company to become liable to S455 tax on loans owed to it by you. In practice, in most owner managed businesses the owners and directors will be the same people. Also, be aware that making a loan to your children or spouse won’t help avoid the S455 charge as they are drawn into the net as associates.
How much is the S455 tax?
The S455 tax rate is the same as the higher rate dividend tax rate (33.75% as at March 2024). This is to act as a disincentive to owner managers taking money out of the business by way of a loan, rather than paying dividends. It is paid by the company rather than you personally and is due to be paid at the same time as any corporation tax payment i.e. 9 months and 1 day after the company’s year end.
Can I avoid paying it?
The good news is yes, you can avoid paying it. Even if you have had a loan from the company, provided you pay it back within 9 months of the year end in which you received it, no S455 tax is due.
It’s important to note that this tax is not permanent. Even if you don’t manage to repay your loan within 9 months of the year end, you can still reclaim the S455 when the loan is repaid to the company. However, the reclaim process can only occur nine months after the end of the accounting period in which the repayment is made, which can affect cash flow.
What if I repay the loan within 9 months and take a new loan?
Nice thinking! Unfortunately, HMRC have also thought of this scenario and have rules to prevent it, called bed and breakfasting rules. Broadly speaking, if the repayments are £5000 or more and new amounts of £5000 or more are taken out within 30 days of the repayment, then the repayment is treated as being made against the new sums withdrawn and not the original amount. This has the effect of leaving the original balance in place and S455 falling due.
Strategies for Managing a Director’s Loan Account
Given the potential tax implications and the need for careful financial management, here are several strategies to effectively manage a director’s loan account:
- Keep accurate records: ensure all transactions are recorded promptly and accurately. This can help avoid disputes and make it easier to ascertain the account’s status at any time.
- Avoid long-term borrowing: if possible, repay any borrowed amounts before the nine-month deadline to avoid the S455 tax charge.
- Plan for tax liabilities: if borrowing from the DLA is unavoidable, plan for the potential tax liabilities in advance to ensure that the company’s cash flow is not adversely affected.
- Consider alternative financing: before borrowing from the DLA, explore other financing options that might be more tax-efficient or cost-effective. You can search for funding options here Business Funding Advice – Services | One Accounting.
- Consult with professionals: given the complexities involved, seeking advice from accounting or tax professionals can help navigate the legal and tax implications effectively.
Our number 1 top tip is this:
Separate your business and personal spending! The company’s money is not the same as your money. Using it as if it is, will just cause additional work and may lead to unforeseen tax bills. It is much better to work out what you need to support your lifestyle and plan for the company to make those payments, usually by a combination of salary and dividends. That way, you can get more certainty over what your tax liabilities are likely to be and budget accordingly.
Conclusion
The Director’s Loan Account offers flexibility for business owners/directors to manage their finances. However, it comes with significant responsibilities and potential tax implications, particularly concerning the S455 tax. By understanding these aspects and properly separating your personal and business spend, directors can ensure that they leverage the benefits of DLAs without falling foul of tax liabilities. Always remember, the key to managing a DLA effectively lies in accurate record-keeping, timely repayment, and, when in doubt, consulting with a professional.
